Cost of Short-Term Financing

1) Commercial Paper

The EPG Mfg. Co. uses commercial paper regularly to support its needs for short-term financing. The firm plans to sell $100 million in 270-day maturity paper on which it expects to have to pay discounted interest at a rate of 12 percent per annum. In addition, EPG expects to incur a cost of approximately $100,000 in dealer placement fees and other expenses of issuing the paper. The effective cost of credit to EPG can be calculated as follows:

APR = [($9,000,000 + $100,000)/($100,000,000 - $100,000 - $9,000,000)] * [1/(270/360)] = 13.35%

2) Accounts Receivable Loans

The AB Co. sells electrical supplies to building contractors on terms of net 60. The firm’s average monthly sales are $100,000; thus given the firm’s 2 month credit terms, its average receivables balance is $200,000. The firm pledges all its receivables to a local bank, which in turn advances up to 70% of the face value of the receivables at 3% over prime and with a 1% processing charge on all receivables pledged. AB follows a practice of borrowing the maximum amount possible, and the current prime rate is 10%.

The APR of using this source of financing for a full year is computed as follows:

APR = [($18,200 + $12,000)/$140,000]*[1/(360/360)] = 21.57%

3) Factoring Accounts Receivable

$100,000 receivable is factored, carrying 60-day credit terms, a 2% factors’s fee, a 6% reserve and interest at 1% per month on advances, then the maximum loan or advance the firm can receive is computed as follows:

Face amount of receivables factored $100,000 Less: fee (2% * $100,000) (2,000) Reserve (6% * $100,000) (6,000) Interest (1% * $92,000 * 2 months) (1,840) Maximum advance $ 90,160

APR = [($1,840 + $2,000)/$90,160] *