Question

Charming Paper Company sells to the 12 accounts listed here:

Account	Receivable balance outstanding	Average age of account over the last year
A	\(60,800	22
B	\)168,000	43
C	\(78,300	19
D	\)24,300	55
E	\(58,900	42
F	\)238,000	39
G	\(30,400	16
H	\)374,000	72
I	\(41,400	32
J	\)96,500	58
K	\(292,000	17
L	\)67,700	37

Capital Financial Corporation will lend 90 percent against account balances that have averaged 30 days or less; 80 percent for account balances between 31 and 40 days; and 70 percent for account balances between 41 and 45 days. Customers that take over 45 days to pay their bills are not considered acceptable accounts for a loan.

The current prime rate is 15.5 percent, and Capital charges 4.5 percent over prime to Charming as its annual loan rate.

b. Determine how much one month’s interest expense would be on the loan balance determined in part a.

Short answer

The interest expense of one month is $14,226.

Step-by-step solution

Calculation of maximum amount of money that can be taken by the company

The maximum amount that can be given as a loan is $851,860.

$\begin{array}{rcl}\mathrm{Maximum}\mathrm{amount}\mathrm{of}\mathrm{loan}& =& \mathrm{Loan}\mathrm{amount}\times \mathrm{Percentage}\mathrm{that}\mathrm{can}\mathrm{be}\mathrm{qualified}\mathrm{as}\mathrm{loan}\\ & =& \left(\$461,500\times 90\%\right)\times \left(\$347,100\times 80\%\right)+\left(\$226,900\times 70\%\right)\\ & =& \$851,860\end{array}$

Calculation of one month’s interest expense

The interest expense for one month is $14,226.

$\begin{array}{rcl}\mathrm{Interest}\mathrm{expense}& =& \mathrm{Interest}\mathrm{rate}\times \mathrm{Maximum}\mathrm{amount}\mathrm{of}\mathrm{loan}\mathrm{that}\mathrm{can}\mathrm{be}\mathrm{taken}\mathrm{by}\mathrm{the}\mathrm{company}\\ & =& \frac{20\%}{12\mathrm{months}}\times \$851,860\\ & =& \$14,226\end{array}$