Hi I have a question about the effective cost of factoring.
In a question our teacher gave us, it said:
"factor charge 1% + interest rate of 18% on all monies advanced, monthly sale $125,000 and factor advances 80% receivables submitted after deducting the 1% fee and the interest, credit term is net 30 days. What amount can the company receive from the factoring company?"
Amount of A/R submitted 125,000
(-) 20% reserve (25,000)
factoring amount =100,000
(-) 1% factor's fee (1,250)
(-) 18% interest for 30 days on 100,000 (1,500)
amount to be received immediately = 97,250
1% factor's fee for 1 year (15,000) = (1,250 x 12)
18% interest for one year (18,000) = (1,500 x 12)
total cost = (33,000)
amount to be received 97,250
effective rate 33,000/97250 = 33.93% /year
--> the part I don't understand is the effective cost part. I don't understand why in calculating the effective rate of cost, you are dividing $33,000, which is a yearly sum of costs versus $97,250, which is a monthly sum of the money you receive. I get effective interest when it's about loans that are taken out for a year - but in that case, the costs as well as the money you receive are all for the year. In the cause of the above factoring question, the amount to be received used in calculating the effective interest is a monthly sum. If the factor's fee was multiplied by 12 to represent the yearly costs, then why isn't the amount to be received in factoring also multipled by 12?