The firm has an average collection period of 34 days. Current practice is to factor all receivables immediately at a discount rate of (1+0.1*x)%. Assume that default is extremely unlikely. What is the effective annual interest rate on this arrangement? A) 11.39 percent B) 12.61 percent C) 13.84 percent D) 15.08 percent E) 16.34 percent
LET X BE 0
Answer is 11.39%
Discount
Rate = (1 + 0.1*x)%
X = 0
Discount Rate = (1 + 0.1*0)%
Discount Rate = 1.00%
Average Collection Period = 34 days
Effective Interest Rate
= [1 + Discount Rate / (1 - Discount Rate)]^[365 / Average
Collection Period] - 1
Effective Interest Rate = [1 + 0.0100 / (1 - 0.0100)]^[365 / 34] -
1
Effective Interest Rate = [1 + 0.0100 / 0.9900]^[365 / 34] -
1
Effective Interest Rate = 1.01010^10.735294 - 1
Effective Interest Rate = 1.1139 - 1
Effective Interest Rate = 0.1139 or 11.39%
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