P1520 similar to faces a liquidity crisitsit needs a loan of

P15-20 (similar to) faces a liquidity crisits-it needs a loan of $126,000 for 1 month Having no source of additional unsecured borrowing, the firm must find a secured short term lender The firm\'s accounts receivable are quite low, but ts inventory is considered lquid and reasonably good collateral. The book value of the inventory is S378,000, of which $151,200 is finished goods. (Note: Assume a 365-day year) The annual interest rate on the loan is 1 1 0% on the (1 ) City-wide Bank will make a S 126,000 t ust recept loan against the finished goods inventory fee levied against the $126,000 initial loan amount Because it will be liquidated as inventory is sold, the average amount owed over the month is expected to be 589.397 (2) Sun State Bank will lend $126,000 against a foating lien on the book value of inventory for the 1-month period at an annual interest rate of 13 ) Citcens\' Bank and Tnst wil lernd S 126,000 against a warehouse receer on the finished goods mentory and charge 152% annual merest on te ottandng oar ha are A 0 54% warto sing tee wil beleved against the average ar ut bo ed Because the loan will be liquidated as i en ryb sold, heaver el balance ise ted to be $75,600 a. Calouiate the dolar cost of each of the proposed plans for oblaining an inihal loun amount of $126.000 Which plan do you recommend? Why? c. Iir the frm had made a purchase or $126. recommended in part b? Why or why not? 000 tor wnoch t had been gven terms of 2/10 net 27, would it ncrease the tmi\'s profitability to give up the discount and not borrow as a. The dollar cost of the trust receiot loan is Round to the nearest cent)

Solution

Inventory financing

a.         City-Wide Bank: = 0.116/12 x $89,397 + 0.0019 x $126,000 = $1,103.57            

Sun State Bank: = 0.133/12 x $126,000 = $1,396.50                                             

Citizens’ Bank: = 0.152/12 x $75,600 + 0.0054 x $75,600 = $1,365.84                 

b.         City-Wide Bank is the best alternative, since it has the lowest cost.

c.         Cost of giving up cash discount = [CD ÷ (100%-CD)] x 365/N

                                                                   [2 ÷ (100 – 2)] x 365/17 = 43.82%

Effective interest rate on loan = Interest/amount received x 12

                                                = 1103.57/89397 x 12 = 14.81%

Since the cost of giving up the discount (43.82%) is higher than borrowing at City-Wide Bank (14.81%), the firm should borrow to take the discount.