1. The Chalfant Company is considering the use of commercial paper to finance a seasonal need for funds. A commercial paper dealer will sell a $25 million issue maturing in 91 days at an annual interest rate of 8.5 percent (deducted in advance). The fee to the dealer for selling the issue is $75,000. Determine Chalfant's annual financing cost of this commercial paper issue.
2. The Boone Furniture Company is considering factoring its receivables. Its average level of receivables is $4 million, and its average collection period is 70 days. Boone's bad-debt losses average $9,000 per month. (Assume 30 days per month.) Factoring receivables will save the company $3,000 per month through the elimination of its credit department. The factor charges a 2 percent commission and requires a 10 percent reserve for returns and allowances. Boone can borrow funds from the factor at 3 percentage points over the prime rate, which is currently 9 percent.
a. Determine the amount of usable funds Boone can obtain by factoring its receivables.
b. Calculate the annual financing cost of this arrangement.