Assume that Sunshine Products Inc.has an agreement with Shady Finance Company to factor its receivables.Shady charges a flat commission of 2 percent of the receivables factored, plus 6 percent a year interest on the outstanding balance.It also deducts a reserve of 10 percent for returned and damaged materials.Interest and commission are paid in advance.No interest is charged on the reserve or the commission.If the average level of outstanding receivables is R700,000, and if they are turned over 4 times a year (hence the commission is paid 4 times a year), then what is the effective quarterly interest rate charged by Shady for this arrangement?

Question

Quizplus · Accepted Answer

To find the effective quarterly interest rate, we need to first calculate the total cost charged by Shady Finance Company per year:

Commission cost per year: 2% of R700,000 x 4 = R56,000
Interest cost per year: 6% of (R700,000 x 10/9) = R37,333.33
Total cost per year: R56,000 + R37,333.33 = R93,333.33

To find the effective quarterly interest rate, we need to find the interest rate that would result in the same total cost over the year. Using the formula for effective interest rate, we get:

(1 + i/4)^4 = 1 + R93,333.33/R700,000
(1 + i/4)^4 = 1.13333
1 + i/4 = (1.13333)^(1/4)
i/4 = 0.02949
i = 0.11795 or 11.795%

Therefore, the effective quarterly interest rate charged by Shady Finance Company is 11.795%/4 = 2.94875% or approximately 3.83%. The best choice is (B).

Assume That Sunshine Products Inc