AICPA Exam CPA-Business Topic 2 Question 76 Discussion

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 four alternative sources of funds, which are given below.

A: 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 of 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.

B: Borrow $110,000 from a bank at 12 percent interest. A 9 percent compensating balance would be required.

C: Issue $110,000 of six-month commercial paper to net $100,000. (New paper would be issued every 6 months.)

D: Borrow $125,000 from a bank on a discount basis at 20 percent. No compensating balance would be required. Assume a 360-day year in all of your calculations.

The cost of Alternative B is: