Question

The Management of Working Capital 715 Pledging Accounts Receivable: Concept Connection Example 16-4 (page 683) Jenkins Appliances has cash flow problems and needs to borrow bet ween $50,000 and $60,000 for pproximately sixty (60) days. Because the business is small and relatively new, unsecured loans are very hard to get and are expensive when they are available. The bank has offered such a loan at 25%. Climax Inc, a finance company, has offered an alternative loan if receivables are pledged as collateral. Climax will lend 70% of the average receivables balance for 14% plus an administrative fee of $1,200.Jenl ins' average receivables balance is $80,000. Which alternative should Jenkins choose? Calculate using a 360-day year. Assume the bank is willing to lend the same amount as Climax

Answer 1

1)	Cost of bank loan for 60 days = 25%*60/360 =	4.17%
2)	Cost of loan from the finance company = (1200+80000*70%*14%*60/360)/(80000*70%) =	4.48%
	As the interest rate (60 days) of the bank loan is
	lower, it should be chosen.