Question

The Bone Company Ltd. has been factoring its accounts receivable for the past five years. The factor charges a fee of 2 % and will lend up to 80 % of the volume of receivables purchased for an additional 1.5 % per month. The firm typically has sales of $500,000 per month, 70 % of which are on credit. By using the factor, the company saves $2,000 per month that would be required to support a credit department, and saves a bad-debt expense of 1% on credit sales. The firm's bank has recently offered to lend the firm up to 80 % of the face value of the accounts receivables shown on the schedule of accounts receivable. The bank would charge 15 % per annum interest plus a 2 % monthly processing charge per dollar of receivables lending. The firm extends terms of net 30, and all customers who pay their bills do so by the thirtieth day.

Required:

Should the firm discontinue its factoring arrangement in favour of the bank's offer if the firm borrows, on the average, $100,000 per month on its receivables?

Answer 1

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Answer:

	Adding opportunity cost of loss on savings by Not factoring
a	cost of credit department		2,000
b	bad debt expense=credit sales x 1%=$350,000 x 1%		3,500
	Total cost for factoring arrangement per month		8,750
	So the firm should continue with factoring arrangement as the costs
	per month for factoring arrangement at $8,500 is less than the costs
	per month for bank financing arrangement for receivables at $8,750