Cooley Industries needs an additional $500,000, which it plans to obtain through
ID: 2514618 • Letter: C
Question
Cooley Industries needs an additional $500,000, which it plans to obtain through a factoring arrangement. The factor would purchase Cooley’s accounts receivables and advance the invoice amount, minus a 2 percent commission, on the invoices purchased each month. Cooley sells on terms of net 30 days. In addition, the factor charges a 12 percent annual interest rate on the total invoice amount, to be deducted in advance.
A. What amount of accounts receivable must be factored to net $500,000?
B. If Cooley can reduce credit expenses by $3,500 per month and avoid bad debt losses of 2.5 percent on the factored amount, what is the total dollar cost of the factoring arrangement?
C. What would be the total cost of the factoring arrangement if Cooley’s funding needs rose to $750,000?
D. Would the factoring arrangement be profitable under these circumstances? Assume the conditions described in part b exist.
$13,532
Accounts receivables needed to factor: $357,447 Monthly costs: Commission $4,468 Interest 2,979 Total monthly costs $7,447 Monthly savings: Credit expense $5,000 Bad debt losses 3,574 Total monthly savings $8,574 Net monthly savings $1,128 Net annual savings$13,532
Explanation / Answer
Given factoring terms are:
Factoring discount = 2%; Annual interest rate = 12% per annum.
a.
Since interest rate is 12% per annum; it can be taken as 1% for the 30 days.
Let x be the gross amount of accounts receivable. Then, Net amount received = x*(1-0.01-0.02) = 0.97X.
If 0.97x = 500,000 (amount required by Cooley)
Therefore gross amount required = 500,000 / 0.97 = 515,464
b.
Expenses saved per month = 3500; and Annual bad debts saving = 581395*2.50% = 14,535.
If factoring costs are 515464 - 500,000 = 15464; and Savings = (3500*12) + 14,535 = 56,535;
Net factoring savings = 56535 - 15464 = 41,071.
c.
In case the amount required is 750,000;
Total gross amount of accounts receivable required = 750000 / 0.97 = 773,196
Factoring savings = 773,196 - 750,000 = 23,196.
Savings due to factoring = (773196 * 2.50% ) + 3500*12= 19330+ 42000 = 61,330.
Hence, net factoring savings = 61330 - 23196 = 38,134.
Therefore, it is a profitable arrangement.
d.
Given that the factoring commission offered would be increased to 2.50%; resulting the interest to reduce to 10.50%.
New gross amount required = 500000 / (1-0.025-(0.1050 / 12))
= 500000 / 0.96625 = 517464. Therefore new factoring cost = 517464 - 500000 = 17464.
Old factoring cost = 15464.
Hence, the old factoring cost was lower compared to new one.