The Naylor Corporation is considering two methods of raising working capital: (1) a commercial bank loan secured by accounts receivable and (2) factoring account receivables. Naylor’s bank has agreed to lend the firm 75 percent of its average monthly accounts receivable balance of $250,000 at the annual interest rate of 9 percent. The bank loan is in the form of a series of 30-day loans. The loan would be discounted and a 20 percent compensating balance would also be required.
A factor has agreed to purchase Naylor’s accounts receivable and to advance 85 percent of the balance of the firm. The 15 percent of receivables not loaned to the firm under factoring arrangement is held in a reserve account. The factor would charge a 3.5 percent factoring commission and annual interest of 9 percent on the invoice price, less both the factoring commission and the reserve account. The monthly interest payment would be deducted from the advance. If Naylor chooses the factoring arrangements, it can eliminate its credit department and reduce operating expenses by $4,000 per month. In addition, bad debt losses of 2 percent of the monthly receivable will be avoided.

a. What is the annual cost associated with each financing arrangement?
b. Discuss some consideration other than cost that may influence management’s decision between factoring and a commercial bank loan.