PROBLEM: Pledging Accounts Receivable: Example 16-4 (page 696) 12. Jenkins Appli

Question

PROBLEM:

Pledging Accounts Receivable: Example 16-4 (page 696)

12.         Jenkins Appliances has cash flow problems and needs to borrow between $50,000 and $60,000 for approximately sixty (60) days. Because the business is small and relatively new, unsecured loans are very hard to get and are expensive when they are available. The bank has offered such a loan at 25%. Climax Inc., A finance company, has offered an alternative loan if receivables are pledged as collateral. Climax will lend 70% of the average receivables balance for 14% plus an administrative fee of $1,200. Jenkins’ average receivables balance is $80,000. Which alternative should Jenkins choose? Calculate using a 360-day year. Assume the bank is willing to lend the same amount as Climax.

SOLUTION:   (+4pts EC)

Explanation / Answer

Step1: Computation of interest cost for loan amount given by Climax.We have,

Loan amount = 70% of the average receivables balances

Loan amount = 70% x 80,000 = $ 56,000

Interest cost = 56,000 x 14% x 60/360 = $ 1,306.67

Total cost for the loan = Interest cost + administrative cost

Total cost for the loan = 1,306.67 + 1,200 = $ 2,506.67

Step2: Computation of interest cost for loan given by bank.We have,

  Interest cost = 56,000 x 25% x 60/360 = $ 2,333.33

Since, the loan given by bank has less interest cost than Climax. So, it should be choose.

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