In order to convert Account Receivable into faster cash a co

In order to convert Account Receivable into faster cash, a company can sell its accounts receivable to another company, called a factor, at a discount. Assume your average credit sales are $50 million per year and average accounts receivable are $5 million. A factoring company offers you an agreement that it will be buying your accounts receivable at a 2.70% discount. Your bank offers you a credit at R% per year (actual yearly rate). What would be the minimum R% for which you would choose factoring? That is, what is the rate R% offered by the bank at or below which you would rather borrow money from the bank instead of factoring? Express your answer as a percentage; for example, the answer 3.18% should be entered as 3.18 without the percentage sign. (Hint: Refer to the Factoring Practice Problem. Assume 360 days in a year. Monthly bank interest rate to be paid is annual rate/12)

Solution

Average collection period in days = 5*360/50 = 36 Discount at 2.7% = 5*2.7% = $         0.135 million Effective rate for 36 days = 0.135/(5-0.135) = 2.77% Maximum payable bank interest = 2.77%*360/36 = 27.70%