Following is the sales information in respect of Bright Ltd: Particulars ₹ Annual Sales (90 % on credit) 7,50,00,000 Credit period 45 days Average…

Evaluation of Factoring Proposal Particulars Particulars ₹ A. Savings due to factoring Bad Debts saved 0.75% x 7.5 crores x 90% 5,06,250 Administration cost saved 18.6 lakhs x 2/5 7,44,000 Interest saved due to reduction in average collection period 7.5 crores x 90% x (70-45)/ 360 x 12.5% 5,85,937.5 Total 18,36,187.5 B. Costs of factoring: Service charge 7.5 crores x 90% x 2% 13,50,000 Interest cost 1,15,171.875 x 360/45 9,21,375 Redundancy Payment 50,000 Total 23,21,375 C. Net Annual cost to the Firm: (A-B) 4,85,187.5 Rate of effective cost of factoring 4,85,187.5/ 64,66,078.125 x 100 7.504% Advice: Since the rate of effective cost of factoring is less than the existing cost of capital, therefore, the proposal is acceptable. Credit Sales = 7.5 crores x 90% = 6,75,00,000 Average level of receivables = 6.75 crores x 45/360 = 84,37,500 Service charge = 2% of 84,37,500 = 1,68,750 Reserve = 20% of 84,37,500 = 16,87,500 Total (i) = 18,56,250 Thus, the amount available for advance is Average level of receivables = 84,37,500 Less: Total (i) from above = 18,56,250 (ii) = 65,81,250 Less: Interest @ 14% p.a. for 45 days = 1,15,171.875 Net Amount of Advance available = 64,66,078.125 Note: Alternatively, if redundancy cost is taken as irrelevant for decision making, then Net Annual cost to the Firm will be - 4,35,187.5 and Rate of effective cost of factoring will be - 4,35,187.5/64,66,078.125 x 100 = 6.730% If average level of receivables is considered for 70 days then the calculation can be done in following way: Evaluation of Factoring Proposal Credit Sales = 7.5 crores X 90% = 6,75,00,000 Average level of receivables = 6.75 crores x 70/360 = 1,31,25,000 Service charge = 2% of 1,31,25,000 = 2,62,500 Reserve = 20% of 1,31,25,000 = 26,25,000 Total (i) = 28,87,500 Thus, the amount available for advance is Average level of receivables = 1,31,25,000 Less: Total (i) from above = 28,87,500 (ii) = 1,02,37,500 Less: Interest @ 14% p.a. for 45 days = 1,79,156.25 Net Amount of Advance available = 1,00,58,343.75 Note 1: Accordingly, interest cost will be - 14,33,250 cost of factoring will be 28,33,250. Therefore, Rate of effective cost of factoring is 9.913% Note 2: Alternatively, if redundancy cost is taken as irrelevant for decision making, then Net Annual cost to the Firm will be - 9,47,062.5 and Rate of effective cost of factoring will be - 9,47,062.5/1,00,58,343.75 x 100 = 9.416%. Advice: Since the rate of effective cost of factoring is less than the existing cost of capital, therefore, the proposal is acceptable.