Cost of Short-Term Financing
1) Commercial Paper
The EPG Mfg. Co. uses commercial paper regularly to support its needs for short-term financing. The firm plans to sell $100 million in 270-day maturity paper on which it expects to have to pay discounted interest at a rate of 12 percent per annum. In addition, EPG expects to incur a cost of approximately $100,000 in dealer placement fees and other expenses of issuing the paper. The effective cost of credit to EPG can be ...view middle of the document...
2) Accounts Receivable Loans
The AB Co. sells electrical supplies to building contractors on terms of net 60. The firm’s average monthly sales are $100,000; thus given the firm’s 2 month credit terms, its average receivables balance is $200,000. The firm pledges all its receivables to a local bank, which in turn advances up to 70% of the face value of the receivables at 3% over prime and with a 1% processing charge on all receivables pledged. AB follows a practice of borrowing the maximum amount possible, and the current prime rate is 10%.
The APR of using this source of financing for a full year is computed as follows:
APR = [($18,200 + $12,000)/$140,000]*[1/(360/360)] = 21.57%
3) Factoring Accounts Receivable
$100,000 receivable is factored, carrying 60-day credit terms, a 2% factors’s fee, a 6% reserve and interest at 1% per month on advances, then the maximum loan or advance the firm can receive is computed as follows:
Face amount of receivables factored $100,000
Less: fee (2% * $100,000) (2,000)
Reserve (6% * $100,000) (6,000)
Interest (1% * $92,000 * 2 months) (1,840)
Maximum advance $ 90,160
APR = [($1,840 + $2,000)/$90,160] * [1/(60/360)]