IWT International Warehousing and Transport needs €400,000 to finance an anticipated expansion in receivables due to increased sales. IWT’s credit terms are net 60, and its average monthly credit sales are €250,000. In general, the firm’s customers pay within the credit period; thus, the firm’s average accounts-receivable balance is €500,000. Patrick McCallan, IWT’s controller, approached the firm’s bank with a request for a loan for the €400,000 using the firm’s accounts receivable as collateral. The bank offered to make a loan at a rate of 2.5 percent over prime plus 1 percent processing charge on all receivables pledged (€250,000 per month). Furthermore, the bank agreed to lend up to 80 percent of the face value of the receivables pledged.

a. Estimate the cost of the receivables loan to IWT when the firm borrows the €400,000. The prime rate is currently 5.5 percent.

b. Patrick also requested a line of credit for €400,000 from the bank. The bank agreed to grant the necessary line of credit at a rate of 3 percent over prime and required a 20 percent compensating balance. IWT current maintains an average demand deposit of €30,000. Estimate the cost of the line of credit to IWT.

c. Which source of credit should the firm select? Why?