IAA umited is considering factoring its accounts receivables. It sells on credit only and its cllection period is not more than 60 days in a year of 365 days. The firm has been experiencing severe cash flow problems lately and is advised to consider factoring its debtors. An institution is prepared to offer the following factoring terms:

75% on each invoice will be paid immediately and interest will be charged at 1% above the current prime rate of 18.5%. Service fees will be charged at 1.5% of total sales.

Suppliers offer the firm a discount at 2% for cash settlement. Sales subject to discount amount to 40% of its total sales. If the firm were to factor, it is believed that it will save the firm approximately TZS 35,000,000/= in expenses. Its total sales per annum are TZS

4,000,000,000/=.

Required:

1. Calculate the effective cost of factoring,
2. Is this form of financing effective in this case? Explain.