Something Wrong Limited (SWL) 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 an unsecured bank loan agreement. The company can borrow $4,000,000 from Always Misleading Clients (AMC) bank for four months with 8% compensating balances and a 10% yearly interest basis with a discount option. AMC will charge a 3% commitment fee on the unused part of the loan. Historically SWL borrows 90% of the usable fund.

The alterntive option relates to factoring its account receivables. SWL Limited generates annual credit sales of $16 million, with an average collection period is four months. Historically, 97% of SWLs credit sales are good and collectible. SWL is considering factoring its A/R balances with AMC at a 10% annual interest rate and 6% reserve requirement. AMC charges a factoring commission of 2.5%. The operating cost of the credit administration department per collection cycle is $8000, while the cost for collection is 2.1% on credit sales.

a. Determine the EAR of unsecured bank loan agreement and factoring account receivables. (3+4 Marks).

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