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Hello !
Revised receivables= 2042466. 80% advance of this value will be given by the factor.
However bold co has to pay an interest rate which is 2% higher the current 7% on its overdraft.
I calculated the additional interest payment as 2042466* 80%*9%. But the examiner has done it like this, 2042466*80%*2%. Why ?You can either show the full cost of 9% and the full saving on the lower receivables at 7%, or alternatively for the amount from the factor you can just show the extra 2%.
The final net cost or saving will be exactly the same either way.
Im sorry but i dont quite understand. How can the answer be same ? I have already shown the savings at 7% and they are 1457535 (fall in receivables)* 7%. Now, if I show the cost at 9%, the cost will increase and the answer will be different from the examiner.
There is no need to apologise.
The alternative way of getting the same answer is as follows:
The factors interest charge is 9% x 0.8 x 2042466 = $147,048
Given that the factor effectively becomes the debtor and so they receive 80% immediately and 20% after 35 days, the average collection period becomes (80% x 0) + (20% x 35) = 7 days. So the new average receivables = 7/365 x $21,300,000 = $408,493, and the interest saving is: ($3,500,000 – 408,493) x 7% = $216,405
Everything else in the answer remains the same and the overall net benefit will be the same.
(The finance cost saving less the interest on advances is either 102,027 – 32,679 = 69,348 as in the printed answer, or using the alternative above is 216,405 – 147,048 = 69,347. (The $1 rounding difference is irrelevant!!))
Either approach is fine – I find my approach above more logical.
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