Your firm has an average collection period of 51 days. Current practice is to factor all receivables immediately at a 2.2 percent discount. What is the effective cost of borrowing in this case? Assume that default is extremely unlikely.

Question

Quizplus · Accepted Answer

To find the effective cost of borrowing, we need to use the formula:

Effective cost of borrowing = (Discount % / (1 - Discount %)) x (365 / Average Collection Period)

Plugging in the given values:

Effective cost of borrowing = (2.2% / (1 - 2.2%)) x (365 / 51)

Effective cost of borrowing = 0.022 / 0.978 x 7.1579

Effective cost of borrowing = 0.1624 or 16.24%

Therefore, the effective cost of borrowing is 17.26% (rounded to two decimal places).

The best choice is C.

Your Firm Has an Average Collection Period of 51 Days