Question

# ​(Cost of secured​ short-term credit​) The Marlow Sales and Distribution Co. needs ​\$500,000 for the​ 3-month...

​(Cost of secured​ short-term credit​) The Marlow Sales and Distribution Co. needs ​\$500,000 for the​ 3-month period ending September​ 30, 2018. The firm has explored two possible sources of credit. a. Marlow has arranged with its bank for a ​\$500,000 loan secured by its accounts receivable. The bank has agreed to advance Marlow 85 percent of the value of its pledged receivables at a rate of 10 percent plus a 1 percent fee based on all receivables pledged.​ Marlow's receivables average a total of​ \$1 million​ year-round. b. An insurance company has agreed to lend the ​\$500,000 at a rate of 8 percent per​ annum, using a loan secured by​ Marlow's inventory of salad oil. A​ field-warehouse agreement would be​ used, which would cost Marlow ​\$2,200 a month. Which source of credit should Marlow​ select? Explain. Note​: Assume a​ 30-day month and​ 360-day year.

Interest expense = (\$1,000,000 - \$500,000) x 10% x 85%
= \$42,500

Processing fee = \$1,750,000 x 1% x 12
= \$210,000

APR = (Interest expense + Processing fee) / Credit extended) x (1 / Time)
= (\$42,500 + \$210,000) / \$500,000) x 1 / 90 / 360
= (\$252,500 / \$500,000) x 360 / 90
= 2.02 or 202%

Compensating cost = \$2,200 x 3 = \$6,600

Interest expense = \$500,000 x 8% x 3 /12
= \$10,000

APR = (Interest expense + Processing fee) / Credit extended) x 1 / Time
= (\$10,000 + \$6,600) / \$500,000 x 360/90
= 13.28%

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