A company enters into an agreement with a firm that will factor the company’s accounts receivable. The factor agrees to buy the company’s receivables,... Accounting MCQs | Accounting MCQs

A company enters into an agreement with a firm that will factor the company’s accounts receivable. The factor agrees to buy the company’s receivables, which average $100,000 per month and have an average collection period of 30 days. The factor will advance up to 80% of the face value of receivables at an annual rate of 10% and charge a fee of 2% on all receivables purchased. The controller of the company estimates that the company would save $18,000 in collection expenses over the year. Fees and interest are not deducted in advance. Assuming a 360-day year, what is the annual cost of financing?

10.0%
12.0%
14.0%
17.5%Show Result

Correct - Your answer is correct.

Wrong - Your answer is wrong.

Detailed Answer

Answer (D) is correct. The first step is to calculate the amount the firm will receive from the factoring transaction: Amount of receivables $100,000 Times: advance percentage × 80
Amount received $ 80,000
This amount is the basis for the calculation of interest expense: Amount advanced $ 80,000 Times: annual finance charge × 10
Annualized interest expense $ 8,000
The next step is to calculate the net outlay: Amount of receivables $100,000 Times: factor fee percentage × 2
Monthly factor fee $ 2,000 Times: months × 12
Annual factor fee $ 24,000 Less: annual savings (18,000
Net outlay $ 6,000
Now the net cost in dollar terms can be determined: Annualized interest expense $ 8,000 Net outlay 6,000
Annual net cost $ 14,000
As with all financing arrangements, the effective rate is the ratio of the amount the firm must pay to the amount the firm gets use of: Effective rate = Net cost ÷ Usable funds = $14,000 ÷ $80,000 = 17.5%