Washington Farm Enterprise, Inc. is considering obtaining funding through advances against receivables. Total annual credit sales are $900,000, terms are net 30 days, and payment is made on an average of 30 days. Brooks Union Bank will advance funds under a pledging arrangement for 12 percent annual interest. On average, 75 percent of credit sales will be accepted as collateral. Commodity Finance offers factoring on a nonrecourse basis for a 1 percent factoring commission, charging 1.25 percent per month on advances and requiring a 15 percent factor's reserve. Under this plan, the firm would factor all accounts and close its credit and collections department, saving $14,000 per year.
(a) What is the effective interest rate and the average amount of funds available under pledging and under factoring?
(b) Which plan do you recommend? Why?