Acme Wram Limited (AWL) plans to identify the best options among two possible alternatives to finance its working capital based on an effective annualized rate (EAR).

The first option relates to financing via issuing commercial paper. AWLcan issue commercial paper (CP) totaling $4,000,000 with 120 days of maturity. Each commercial paper certificate will have a face value of $1000 and can be issued at a discount of 4%. As the issue manager, Always Misleading Clients (AMC) will charge a 1.5% commission on the face value of the CP. An additional 0.5% will be used for printing and stamp duty purposes for each CP.

The alterantive option relates to factoring its account receivables. AWL Limited generates annual credit sales of $16 million, with an average collection period is four months. Historically, 96% of AWLs credit sales are good and collectible. AWL is considering factoring its A/R balances with AMC at a 10% annual interest rate and 6% reserve requirement. AMC, the factor, charges a factoring commission of 3.5%. The operating cost of the credit administration department per collection cycle is $8000, while the cost for collection is 3.1% on credit sales.

a. Determine the EAR of financing via commerical paper issue and factoring account receivables. (3 + 4 Marks).

b. Which option should AWL choose? (1 Mark)