Question One

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

50% on each invoice will be paid immediately and interest will be charged at 2% above the current prime rate of 15.5%. Service fee will be charged at 2% of total sales. Suppliers offer the firm a discount at 2% for cash settlement. Sales subject to discount amount to 50% of its total sales. If the firm were to factor, it is believed that it will save the firm approximately TZS 40,000,000/= in expenses. Its total sales are TZS 6,000,000,000/=

Required:

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