Question

Tremont Trucking is considering factoring its receivables. The company’s average collection period is 30 days, and its average level of receivables is $5.0 million. Tremont’s bad-debt losses average $25,000 every month. If the company factors its receivables, it will save $35,000 a month by eliminating its credit department. The factor has indicated that it requires a 2.0 percent factoring commission and a 2.5 percent reserve for returns and allowances. The factor will advance Tremont funds at 0.75 percentage point over prime, which is currently 3.25 percent. Determine the annual financing cost after considering cost savings and bad-debt losses (the net AFC).

Answer 1

To determine the annual financing cost (net AFC) after factoring its receivables, we need to consider the cost savings and bad-debt losses. The formula to calculate the net AFC is: Net AFC = Factoring Commission + Financing Cost - Cost Savings - Bad-debt Losses.

Step-by-step explanation:

To determine the annual financing cost (net AFC) after factoring its receivables, we need to consider the cost savings and bad-debt losses. First, let's calculate the cost savings: Tremont Trucking will save $35,000 per month by eliminating its credit department, which amounts to $420,000 annually. Next, let's calculate the bad-debt losses: Tremont's bad-debt losses average $25,000 per month, which amounts to $300,000 annually.

The factor requires a 2.0 percent factoring commission and a 2.5 percent reserve for returns and allowances. The factor will advance funds at 0.75 percentage point over prime, which is currently 3.25 percent.

To calculate the annual financing cost, we can use the following formula:

Net AFC = Factoring Commission + Financing Cost - Cost Savings - Bad-debt Losses