Sunny Coast Enterprises (A). Sunny Coast Enterprises has sold a combination of f

Question

Sunny Coast Enterprises (A). Sunny Coast Enterprises has sold a combination of films and DVDs to Hong Kong Media Incorporated for US$103,000, with payment due in five months. Sunny Coast Enterprises has the following alternatives for financing this receivable: 1) Use its bank credit line Interest would be at the prime rate of 5.2% plus 150 basis points per annum. 2) Use its bank credit line but purchase export credit insurance for a 1% fee. Because of the reduced risk, the bank interest rate would be reduced to 5.2% per annum without any points. In both cases Sunny Coast would need to maintain a compensating balance of 22% of the loan's face amount, and no interest will be paid on the compensating balance by the bank a. What are the annualized percentage all-in costs of each alternative? b. What are the advantages and disadvantages of each alternative? c. Which alternative would you recommend? (NOTE: Assume a 360-day year.) a. What are the annualized percentage all-in costs of each alternative? Alternative 1: Bank Credit Line The bank interest expense on the receivable is $ Calculate the net proceeds below: (Round to the nearest cent.) (Round to the nearest cent.) Alternative 1 Face amount of receivable Less bank interest expense on receivable Less compensating balance requirement Net proceeds Help & Support The annualized percentage all-in cost Alternative 2: Bank Credit LineExport Credit Insurance The bank interest expense on the receivable is $ (AIC) is %. (Round to three decimal places.) (Round to the nearest cent.)

Explanation / Answer

1.) Alternative-1

Face amount of Receivable      =$103,000

Less Bank Interest Expenses   =$1.5% x 103,000 + 0.052 x 103,000 x 5/12 =$1,545 + 2,231.67=$3,776.67

Compensating Balance             = 0.22 x 103,000 =$22,660

Net Proceeds                            =$ 103,000 - 3,776.67 - 22,600 =$76,623.33

Annualized Percentage all in costs =(3776.67/76,623.33)x100x12/5 =11.829%

Alternative-2

Face amount of Receivable      =$103,000

Credit Insurance Fee                =$0.01x103,000 =$1,030

Less Bank Interest Expenses   =$0.052 x 103,000 x 5/12 =$2,231.67

Compensating Balance             = 0.22 x 103,000 =$22,660

Net Proceeds                            =$ 103,000 - 1,030 -2,231.67 - 22,600 =$77,138.33

Annualized Percentage all in costs =3261.67/77,138.33X100X12/5=10.148%

1b.) Better credit terms are made possible with Credit Insurance with the disadvantage that it has to bough upfront. The given statement is True

1c.) I will recommend going with Alternative-2 since it will provide insurance on the credit and cover the risk for default though it has to be paid upfront.

2.) Alternative-2 is marginally cheaper if we do not account for Time Value of Money.

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