Johnson Enterprises Inc. is involved in the manufacture and sale of electronic c
ID: 2664049 • Letter: J
Question
Johnson Enterprises Inc. is involved in the manufacture and sale of electronic components used in small AM/FM radios. The firm needs $300,000 to finance and anticipated expansion in receivables due to increased sales. Johnson’s credit terms are net 60, and its average monthly credit sales are $200,000. In general, the firm’s customers pay within the credit period; thus, the firm’s average accounts receivable balance is $400,000. Chuck Idol, Johnson’s comptroller, approached the firm’s bank with a request for a loan for the $300,000 using the firm’s accounts receivable as collateral. The bank offered to make a loan at a rate of 2% over prime plus a 1% processing charge on all receivables pledged ($200,000 per month). Furthermore, the bank agreed to lend up to 75% of the face value of the receivables pledged.a. Estimate the cost of the receivables loan to Johnson when the firm borrows the $300,000. The prime rate is currently 11%.
b. Idol also requested a line of credit for $300,000 from the bank. The bank agreed to grant the necessary line of credit at a rate of 3% over prime and required a 15% compensating balance. Johnson currently maintains an average demand deposit of $80,000. Estimate the cost of the line of credit to Johnson.
c. Which source of credit should Johnson select? Why?
Explanation / Answer
a Cost Of receivables : Receivables Pledged 200000 Prime rate 11% Add : 2% Processing fee 1% Total Interest 13%of 200,000 26000 Amount Borrowed from Bank 100000 (300,000- 200,000 ) Interest on above 11% 0f 100,000 11000 Total Cost 37000 b Line of Credit 300000 Interst Rate 14% (11% + 3% ) Amount of Interest 42000 Compensating Balance 15%of 300,000 45000 Since , the firm maintains a demand deposit of $80,000 already, which is greater than compensating balance, no additional deposits need to be made c The firm should select the pledging of receivables since it is less costly.
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