Raymond Manufacturing faces a liquidity crisis: It needs 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 its inventory is considered liquid and reasonably good collateral. The book

value of the inventory is $300,000, of which $120,000 is finished goods. (Note: Assume

a 365-day year.)

(1) City-Wide Bank will make a $100,000 trust receipt loan against the finished

goods inventory. The annual interest rate on the loan is 12% on the outstanding

loan balance plus a 0.25% administration fee levied against the $100,000 initial

loan amount. Because it will be liquidated as inventory is sold, the average

amount owed over the month is expected to be $75,000.

(2) Sun State Bank will lend $100,000 against a floating lien on the book value of

inventory for the 1-month period at an annual interest rate of 13%.

(3) Citizens’ Bank and Trust will lend $100,000 against a warehouse receipt on the

finished goods inventory and charge 15% annual interest on the outstanding

loan balance. A 0.5% warehousing fee will be levied against the average amount

borrowed. Because the loan will be liquidated as inventory is sold, the average

loan balance is expected to be $60,000.

a. Calculate the dollar cost of each of the 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 given terms

of 2/10 net 30, would it increase the firm’s profitability to give up the discount

and not borrow as recommended in part b? Why or why not?