Pula Paper Ltd is a manufacturer of facial tissues. The company needs to borrow $1,000,000 to help finance seasonal inventory build-up prior to the Lunar New Year. The company is considering the following alternatives for financing its working capital.
Option A: The company may issue $1,000,000 in 180-day maturity commercial paper. The paper will carry 12% rate with discounted interest and will cost the company $23,000 to issue.
Option B: Factoring its receivables is another option. The company has credit sales of $217,000 per month and an average receivables balance of $1,302,000 with 180-day credit terms. The factor has offered to extend credit equal to 80% of the receivables less interest on the loan at a rate of 2% per month. The factor will charge a 1% factoring fee on all receivables factored, and will maintain a 19% reserve. If Pula Paper undertakes the loan, it will reduce its own credit department expenses by $1,500 per month.
1 What is the effective cost of the commercial paper for Pulp Paper?
2. What is the effective cost to Pula Paper of the factoring arrangement?