Question

Firms usually offer their customers some form of trade credit. This allowance comes with certain terms of credit. These terms will affect the cost of the asset for both the buyer and the seller.

Consider the following case:

Blue Elk Manufacturing buys most of its raw materials from a single supplier. This supplier sells to Blue Elk on terms of 2/15, net 45. The cost per period of the trade credit extended to Blue Elk, rounded to two decimal places, is_______________% .

Blue Elk’s trade credit has a nominal annual cost—expressed as an annual percentage rate (APR)—of______________% , assuming a 365-day year. (Note: Round all intermediate calculations to four decimal places, and your final answer to two decimal places.)

If Blue Elk’s supplier shortens the discount period by five days, this will(increase or decrease)__________ the cost of the trade credit.

Answer 1

This supplier sells to Blue Elk on terms of 2/15, net 45.

It means if the payment is made within 15 days, customer will get 2 percent discount on payment and maximum payment period allowed is 45 days.

Cost per period = Discount / (100-discount)

= 2 / (100-2) = 2.04%

compute the nominal annual cost = cost per period * ( 365 / (credit period-discount period))

= 2.04% * ( 365 / (45 - 15))

= 24.82%

compute the nominal annual cost (discount period shortened by 5 days)= cost per period * ( 365 / (credit period-discount period))

= 2.04% * ( 365 / (45 - 10))

= 21.27%

cost of credit period decreased by 3.55% (24.82 - 21.27)