Question

Problem 16-04
Cost of Trade Credit

A large retailer obtains merchandise under the credit terms of 3/20, net 40, but routinely takes 70 days to pay its bills. (Because the retailer is an important customer, suppliers allow the firm to stretch its credit terms.) What is the retailer's effective cost of trade credit? Assume 365 days in year for your calculations. Do not round intermediate calculations. Round your answer to two decimal places.

%

Answer 1

3/20 net 40 means 3% Discount is availed if paid by 20th day.  
Otherwise payable by 40th day. But payment are made on 70 days   
So payment days =   70
Discount days =   20
Discount % =   3%
Number of days in year =   365
  
Effective Cost of trade credit foumula =( (1+(Discount%/(1-Discount%)))^365/(Payment days - discount days))-1  
=( (1+(3%/(1-3%)))^(365/(70-20)))-1  
0.2490112204  
or 24.90%  
  
So effective cost of trade credit is 24.90%