Small Business Finance Homework: Chapter 15 Homework Score: 0 of 3 pts Problem 1
ID: 1176044 • Letter: S
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Small Business Finance Homework: Chapter 15 Homework Score: 0 of 3 pts Problem 15-6 (similar to) Save 5 of 16 (0 complete) Hw Score: 0%, 0 of 77 pts Question Help * (Cost of secured short-term credit) The Marlow Sales and Distribution Co. needs $480,000 for the 3-month period ending September 30, 2015. The firm has explored two possible sources of credit a. Marlow has arranged with its bank for a $480,000 loan secured by its accounts receivable. The bank has agreed to advance Marlow 80 percent of the value of its pledged receivables at a rate of 9 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 $480,000 at a rate of 7 percent per annum, using a loan secured by Marlows inventory of salad oil. A field-warehouse agreement would be used, which would cost Marlow $1,800 a month. Which source of credit should Marlow select? Explain. Note: Assume a 30-day month and 360-day year % (Round to two decimal places.) The cost or APR, of the pledging accounts receivable is Enter your answer in the answer box and then click Check AnswerExplanation / Answer
Cost of Borrowing from the bank:
Loan : 480,000 ; Interest Rate : 9% p.a. ; Loan to collateral value : 80% ; Collateral to be pledged : 480000/80% = 600000 (the company has sufficient collateral in form of receivables). We assume partial pledge of receivables since the fee is charged on the value of collateral pledged. Loan fee : 1% of receivables pledged : 1% * 600000 = $6000.
Monthly interest charged will be : 480000 * 9% * 30/360 = 3600
Total cost of the loan : ( 6000 + 3600 + 3600 + 3600 )/ 480000 = 3.5% for 3 months or 14% APR
Cost of borrowing from the insurance company:
Interest rate : 7% p.a. and other costs $ 1800 per month.
Monthly interest : 7% * 480000 * 30/360 = 2800
Total cost of the loan : ( 1800 * 3) + (2800 *3 )/ 480000 = 2.875% for 3 months or 11.5% APR
Hence Marlow should borrow from the Insurance company.
The cost of pledging is 1% upfront but since this is 3 month loan, for Marlow it equates to 4% APR
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