Solved – Because of crop failures last year, the San Joaquin Packing Company has no funds available to finance its canning operations during the next six months

Question

Because of crop failures last year, the San Joaquin Packing Company has no funds available to finance its canning operations during the next six months. It estimates that it will require $1,200,000 from inventory financing during the period. One alternative is to establish a six-month, $1,500,000 line of credit with terms of 9 percent annual interest on the used portion, a 1 percent commitment fee on the unused portion, and a $300,000 compensating balance at all times. The other alternative is to use field warehouse financing. The costs of the field warehouse arrangement in this ease would be a flat fee of $2,000, plus 8 percent annual interest on all outstanding credit, plus 1 percent of the maximum amount of credit extended. Expected inventory levels to be financed are as follows:

MonthAmount
July 1995
August
September
October
November
December
$ 250,000
1,000,000
1,200,000
950,000
600,000
0

a. Calculate the dollar cost of funds from using the line of credit. Be sure to include interest charges and commitment fees. Note that each month’s borrowings will be $300,000 greater than the inventory level to be financed because of the compensating balance requirement.

b. Calculate the total cost of the field warehousing operation.

c. Compare the cost of the field warehousing arrangement with the cost of the line of credit. Which alternative should San Joaquin choose?

Answer

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