Tag (SQ): Interest cost

(A). A business entity offers its customers trade credit of 90 days. It is considering whether to offer a settlement discount of 2% for payment within seven days.

Required

Calculate the cost of offering the discount, as an annual interest cost.

(B). Entity K has monthly sales of GH₵100,000. A factor has offered to take over the administration of Entity K’s trade receivables, on a non-recourse basis (or without recourse basis). It would charge a fee of 4% of the value of invoices processed. If the factor takes over this work, Entity K would save monthly administration costs of GH₵2,000 and would avoid its bad debts, which are 0.75% of sales.

Entity K has been informed by the factor that the average collection period (the time between issuing an invoice and receiving payment from the customer) will be reduced from 2 months to 1 month.

The factor will also provide finance by lending 80% of the value of unpaid invoices, charging interest at an annual rate of 8% on the cash that it lends. At the moment, Entity K finances its trade receivables with bank overdraft finance at 9% per year interest.

Required

Calculate the net effect on annual profits of Entity K if the factor took over the administration of the trade receivables and provided finance on the terms described above.