The Frame Supply Company has just acquired a large account and needs to increase its working capital by $100,000. The controller of the company has id... Accounting MCQs | Accounting MCQs

The Frame Supply Company has just acquired a large account and needs to increase its working capital by $100,000. The controller of the company has identified the four sources of funds given below.
1.Pay a factor to buy the company’s receivables, which average $125,000 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 10% and charge a fee of 2% on all receivables purchased. The controller estimates that the firm would save $24,000 in collection expenses over the year. Assume the fee and interest are not deductible in advance.
2.Borrow $110,000 from a bank at 12% interest. A 9% compensating balance would be required.
3.Issue $110,000 of 6-month commercial paper to net $100,000. (New paper would be issued every 6 months.)
4.Borrow $125,000 from a bank on a discount basis at 20%. No compensating balance would be required.
Assume a 360-day year in all of your calculations.
The cost of Alternative 3 to Frame Supply Company is

9.1%
10.0%
18.2%
20.0%Show Result

Correct - Your answer is correct.

Wrong - Your answer is wrong.

Detailed Answer

Answer (D) is correct. By issuing commercial paper, the company will receive $100,000 and repay $110,000 every 6 months. Thus, for the use of $100,000 in funds, the company pays $10,000 in interest each 6-month period, or a total of $20,000 per year. The annual percentage rate can therefore be calculated as follows: Effective rate = Interest expense ÷ Usable funds = $20,000 ÷ $100,000 = 20.0%