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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 a source of funds which is given below:
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 percent of the face value of receivables at 10 percent and charge a fee of 2 percent 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.
Assume a 360-day year in all of your calculations.
The cost of factoring is:
Suggested Answer: A
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Choice 'a' is correct. 7.0 percent cost of funds from retained earnings.
The cost of retained earnings is equal to the rate of return required by the firm's common shareholders (or, in effect, the return 'lost' by them when the firm chooses to fund with retained earnings). While oftentimes this rate is somewhat subjective, we are given the facts to exactly answer the question in this case. The stock is currently selling for $100/share, and the dividend is given at $7/share.
$7 / $100 = 7%
Choices 'b', 'c', and 'd' are incorrect, per the above Explanation:/calculation.
36 comments · newest first
EA
Earleen
10 months ago
Don’t forget the $24,000 savings in collection costs!
TY
Tyisha
11 months ago
Totally agree, 14.8% makes sense with those fees!
GA
Gabriele
11 months ago
Wait, how can it be that high? Seems off to me.
PO
Portia
11 months ago
I think it's around 14.8% based on the calculations.
TW
Twanna
11 months ago
The factoring cost is based on 80% of $125,000.
ME
Mertie
12 months ago
I think the total cost of factoring is higher than I initially expected. I want to say it could be around 16%, but I’m not completely confident in my calculations.
GI
Giuseppe
12 months ago
I feel like I might be overthinking the average collection period. Does it really impact the cost of factoring directly, or is it just for context?
BE
Beula
12 months ago
This question seems similar to one we did in class about factoring costs. I think we had to calculate the effective interest rate based on advances and fees.
CA
Carma
1 year ago
I remember factoring involves calculating both the fee and the interest, but I'm not sure how to combine those for the total cost.
KR
Kris
1 year ago
The wording of this question is a bit tricky. I'm going to read through it a few times to make sure I understand all the details before I start solving.
LU
Lucille
1 year ago
This seems doable, but I want to double-check my work. I'll make sure to show all my calculations in case I need partial credit.
FI
Filiberto
1 year ago
Okay, I think I've got a handle on this. I just need to plug the numbers into the formula and see which answer choice matches my result.
JO
Jonelle
1 year ago
Hmm, I'm a little confused about the 360-day year assumption. Does that affect the calculations somehow? I'll have to think through that part carefully.
CA
Catarina
1 year ago
This looks like a pretty straightforward finance problem. I'll need to calculate the total cost of factoring the receivables and compare it to the savings from reduced collection expenses.
PE
Pearly
1 year ago
Okay, let me think this through step-by-step. The question mentions "Elementary Comparison Test" and "modified condition/decision coverage", so I'll need to understand how those concepts relate to the graph options.
LA
Laquanda
1 year ago
I'm pretty confident I know the answer to this one. Increasing the network bandwidth or removing the authentication requirements won't solve the underlying issue. A single sign-on mechanism is the way to go.
KI
Kimberlie
1 year ago
This looks like a tricky one. I'll need to think through the different options carefully.
AL
Alison
1 year ago
Guys, I think we're all forgetting the most important factor here: the 360-day year. That's gotta be the key to cracking this question!
TR
Trina
1 year ago
Wait, are we sure this isn't a trick question? Maybe the right answer is actually A) 12.0 percent, and the controller is just trying to confuse us!
GA
Gaston
1 year ago
B) 14.8 percent.
MA
Marylyn
1 year ago
I think you might be onto something there.
DO
Dorathy
1 year ago
A) 12.0 percent.
DY
Dyan
1 year ago
You all are overthinking this. The answer is clearly D) 20.0 percent. Who cares about the collection expenses? The factor is taking 80% of the receivables and charging 10% interest plus a 2% fee. That's 20% total, end of story.
JO
Joanne
1 year ago
No need to complicate things, the cost of factoring is simply 20.0 percent. Let's keep it simple.
CE
Ceola
1 year ago
But what about the collection expenses we would save over the year? Shouldn't we take that into consideration?
HE
Helga
1 year ago
I think you're right, D) 20.0 percent does seem to be the correct answer.
JO
Joseph
1 year ago
I'm going to have to disagree with you guys. I think the answer is C) 16.0 percent. The interest rate is 10%, and the fee is 2%, so that adds up to 12%. But then you have to factor in the savings of $24,000 in collection expenses, which brings the total cost down to 16.0 percent.
CR
Crissy
1 year ago
I agree with you. The answer is indeed C) 16.0 percent. Taking into account the interest rate, fee, and savings, the total cost of factoring would be 16.0 percent.
CA
Carlota
1 year ago
I'm not sure about that. I think the answer is A) 12.0 percent. The interest rate and fee total 12%, and with the savings factored in, the cost should be 12.0 percent.
KA
Kate
1 year ago
I see your point, but I still believe the answer is D) 20.0 percent. The interest rate and fee add up to 12%, and when you include the savings, the total cost would be 20.0 percent.
YO
Yong
1 year ago
I think the answer is B) 14.8 percent. The interest rate is 10%, and the fee is 2%, so that adds up to 12%. But then you have to factor in the savings of $24,000 in collection expenses, which brings the total cost down to 14.8 percent.
JE
Jesusa
1 year ago
Hmm, let me think this through. The factor is taking 80% of the $125,000 receivables, which is $100,000. At 10% interest, that's $10,000. Plus the 2% fee on $125,000 is $2,500. Yep, B) 14.8 percent is the right answer.
CA
Casey
1 year ago
I'm pretty sure the answer is B) 14.8 percent. The factor will advance 80% of the receivables at 10% interest, and charge a 2% fee. That adds up to 14.8% total cost.
RE
Renea
2 years ago
But the controller estimated savings of $24,000, so it must be 14.8 percent.
AI
Aimee
2 years ago
I disagree, I believe it is 16.0 percent.
RE
Renea
2 years ago
I think the cost of factoring is 14.8 percent.