Aunt Tilly's Feeds, Inc. is considering obtaining funding through advances against receivables.

Total
annual credit sales are $600,000, terms are net 30 days, and payment is made on the average of 30 days. Western
National Bank will advance funds under a pledging arrangement for 13 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 1.5 percent per month on advances and requiring a 15 percent
factors reserve. Under this plan, the firm would factor all accounts and close its credit and collections
department, saving $10,000 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?
Answers:
(a) Western National Bank (pledging)

$600,000
(0.75) $37,500
12
funds available
Commodity Finance (factoring)
Average accounts receivable ($600,000/12)
Less: Reserve (15%)

$50,000
7,500

Less: Factoring Commission

Funds available for advance
Less: Interest on advance (1.5% $42,000)
Proceeds from advance

500
$42,000
630
$41,370

Western National effective interest rate 13%

$630
(12) 18.27%
$41,370

Commodity Finance effective interest rate

(b)
Western National
Annual interest cost 37,500 0.13 $4,875
Commodity Finance
Annual interest cost
Factors commission
Total Cost
benefit of closing credit
department
Net Cost

$ 7,560 ( 630 12)

6,000 ( 500 12)
$13,560
10,000
$ 3,560

Since the net cost of factoring receivables is less expensive than pledging receivables and
also provides more available funds, Giant Feeds, Inc. should choose Commodity Finance.