Reference no: EM1376747

Raymond Manufacturing faces a liquidity crisis-it requires a loan of $100,000 for 1 month. Having no source of additional unsecured borrowing,

The firm must find a secured short-term lender. The firm's accounts receivable are quite low, but it's inventory is considered liquid and reasonably good collateral. The book value of inventory is $300,000, of which $120,000 is finished goods.

(1) City-Wide Bank will create a $100,000 trust receipt loan against finished goods inventory. The annual interest rate on loan is 12 percent on the outstanding loan balance plus a 0.25 percent administration fee levied against the $100,000 initial loan amount. Because it can be liquidated as inventory is sold, the average amount owed over month is expected to be $75,000.

(2) Sun State Bank will lend $100,000 against a floating lien on book value of inventory for the 1-month period at an annual interest rate of 13 percent.

(3) Citizens' Bank and Trust will lend $100,000 against a warehouse receipt on finished goods inventory and charge 15 percent annual interest on the outstanding loan balance. A 0.5 percent warehousing fee will be levied against the average amount borrowed. Because loan will be liquidated as inventory is sold, the average loan balance is expected to be $60,000.

a. Evaluate the dollar cost of each of proposed plans for obtaining an initial loan amount of $100,000.

b. Which plan do you recommend? Why?

c. If the firm had made a purchase of $100,000 for which it had been provided terms of 2/10 net 30, would it increase the firm's profitability to provide up the discount and not borrow as recommended in part b? Why or why not?