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 This topic has 5 replies, 3 voices, and was last updated 2 years ago by John Moffat.

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July 31, 2017 at 3:46 pm #399713toushiga
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Q: A company makes annual credit sales of $1,500,000.Credit terms are 30days, but its debt administration has been poor and the average collection period has been 45days with 0.5% of sales resulting in bad debts which are written off.
A factor would take on the task of debt administration and credit checking, at annual fees of 2.5% credit sales .The company would save $30,000 a year in administration costs.The payment period would be 30days.
The factor would also provide an advance of 80% of invoiced debts at an interest rate of 14% (3% over the current base rate). The company can obtain an overdraft facility to finance its accounts receivable at a rate of 2.5 % over base rate
Should the factor’s services be accepted?Assume a constant monthly turnover.I don’t understand one part of the answer provided is :”
Extra interest cost of factor finance 30/365 x$1,200,000 x(1413.5) %=(493)August 1, 2017 at 9:18 am #399783John MoffatKeymaster Topics: 57
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The factor is charging 14% interest.
Because this is 3% over the base rate, it means that the base rate must be 11%.
The overdraft rate is 2.5% over base rate and so is 13.5%
So….the company is paying 14% to the factor to get the money sooner, but is saving 13.5% overdraft interest as a result. So the net extra cost is the difference of 0.5%.
August 1, 2017 at 11:02 am #399808toushiga Topics: 424
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The question says” The factor would also provide an advance of 80%”
If using factoring,why not saving overdraft interest for 20%? $1,500,000 x 20% = $300,000
And $300,000 x 30/365 x 13.5%?
Why they calculate the overdraft interest rate based on $1,200,000 and compare?
Thank you.August 1, 2017 at 3:32 pm #399857John MoffatKeymaster Topics: 57
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The factor is reducing the payment period to 30 days. So (ignoring the advance for the moment) the average receivables will be 30/365 x $1,500,000 throughout the year.
Of this amount, the factor will advance 80% immediately but they will charge 14%. If they didn’t advance it and waited the 30 days, then there would be extra overdraft interest on the amount of 13.5%.
So by have the factor advance the payment of the 80%, it is costing 80% x 30/365 x $1,500,000 x 0.5%
May 8, 2020 at 8:09 am #570294SyahmieAlhakim Topics: 1
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Hi. Can I have the full answer for this question? Tq
May 8, 2020 at 10:49 am #570311John MoffatKeymaster Topics: 57
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We do not provide full answers – we explain issues in answers that students are not clear about (as I have done here).
You should watch my free lectures and you should buy a Revision Kit from one of the ACCA approved publishers (they have full answers and explanations).

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