Johnson Enterprises Inc. is involved in the manufacture and sale of electronic c
ID: 2671529 • Letter: J
Question
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 general, the firm’s customers pay within the credit period; thus, the firm’s average accounts receivable balance is $400,000. Chuck Idol, Johnson’s comptroller, 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 make a loan at a rate of 2 percent over prime plus a 1 percent processing charge on all receivables pledged ($200,000 per month). Furthermore, the bank agreed to lend up to 75 percent of the face 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 credit for $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?
Explanation / Answer
Please rate, here is detailed solution: a Cost Of receivables : Receivables Pledged 200000 Prime rate 11% Add : 2% Processing fee 1% Total Interest 13%of 200,000 26000 Amount Borrowed from Bank 100000 (300,000- 200,000 ) Interest on above 11% 0f 100,000 11000 Total Cost 37000 b Line of Credit 300000 Interst Rate 14% (11% + 3% ) Amount of Interest 42000 Compensating Balance 15%of 300,000 45000 Since , the firm maintains a demand deposit of $80,000 already, which is greater than compensating balance, no additional deposits need to be made c The firm should select the pledging of receivables since it is less costly.
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