Johnson Enterprises Inc. is involved in the manufacture and sale of electronic components used in small AM/FM radios. The firm needs #300,000 to finance an anticipated expansion in receivables due to increased sales. Johnson's credit terms are net 60, and its average monthly credit sales are $200,000. In gereral, the firm's customers pay within the credit period: thus, the firm's average accounts receivable balance is $400,000. Chuck Idol, Johnson's comtroller, approached the firm's bank with a request for a loan for the $300,000 using the firm's accounts receivable as collateral. The bank offered to makea loan at a rate of 2percent over prime plus a 1 percent processing charge on all receivable pledge($200,000 per month). Futhermore, the bank agreed to lend up to 75 percent of the fce value of the receivables pledged.
A.) Estimate the cost of the receivables loan to Johnson when the firm borrows the $300,000. The prime rate is currently 11 percent.
B.) Idol also requested a line of creditfor $300,000 from the bank. The bank agreed to grant the necessary line of credit at a rate of 3 percent over prime and required a 15 percent compensating balance. Johnson currently maintains an average demand deposit of $80,000. Estimate the cost of the line of credit to Johnson.
C.) Which source of credit should Johnson select? Why?