Southern Fabrics Inc. factors all of its receivables. The firm does $150 million in business each year and would have an ACP of 36.5 days if it collected its own receivables. The firm’s gross margin is 35%. The factor operates without recourse and pays immediately upon taking over the accounts. It discounts the gross amount factored by 10% and pays Southern immediately. Because the factor doesn’t collect from customers until they pay, it charges interest at 10% in the interim.

a. Calculate the gross cost of factoring to Southern Fabrics if all receivables are collectible.

b. What interest rate is implied by the arrangement?

c. Suppose Southern is considering giving up the factoring arrangement and handling its own collections. Should the firm do it if bad debt losses are expected to average 3% of gross sales and running a collections department will cost about $1.5 million per year? Assume the interest cost of carrying the receivable balance is also 10%.

d. What is the implied interest rate in the factoring arrangement if the costs in part (c) are taken into account?