Factoring

question 31 from pre-Jun 23 Mock exam

Now to summarize the benefits from this question :

– Is to take the drop of the receivables and calculate the interest on that using the overdraft interest rate
-secondly the advance received from factor on the receivables we have to calculate the interest on the it

so these two interest will the savings from the factor,

But I want some clarification about why the amount of the advance is counted as a saving from the factor only the interest on it,
even though the advance itself is the effect of the factor.

Thanks.
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Q
Extracts from the recent financial statements of Bolder Co are given below:

Statement of profit or loss  
  $000
Revenue 21,300
Cost of sales 16,400
  _______
Gross profit   4,900
  _______
Statement of financial position    
  $000  $000
Non-current assets   3,000
Current assets    
   Inventory 4,500  
   Trade receivables 3,500  
  _____ 8,000
    ______
Total assets   11,000
    ______
Equity    
   Ordinary shares   1,000
   Reserves   1,000
    ______
    2,000
Non-current liabilities: Loan notes   3,000
Current liabilities    
Trade payables 3,000  
Overdraft 3,000  
  _____ 6,000
    ______
Total equity and liabilities   11,000
    ______
A factor has offered to manage the trade receivables of Bolder Co in a servicing and factor-financing agreement.  The factor expects to reduce the average trade receivables collection period of Bolder Co from its current level to 35 days; to reduce bad debts from 0.9% of revenue to 0.6% of revenue; and to save Bolder Co $40,000 per year in administration costs.  The factor would also make an advance to Bolder Co of 80% of the revised book value of trade receivables.  The interest rate on the advance would be 2% higher than the 7% that Bolder Co currently pays on its overdraft.  The factor would charge a fee of 0.75% of revenue on a with-recourse basis, or a fee of 1.25% of revenue on a non-recourse basis.  Assume that there are 365 working days in each year and that all sales and supplies are on credit.

Required:

(a)         Calculate the value of the factor’s offer:

(i)          on a with-recourse basis;

(ii)         on a non-recourse basis.