Question

The Reynolds Corporation buys from its suppliers on terms of 2/11, net 60. Reynolds has not been utilizing the discounts offered and has been taking 60 days to pay its bills. Mr. Duke, Reynolds Corporation vice president, has suggested that the company begin to take the discounts offered. Duke proposes that the company borrow from its bank at a stated rate of 16 percent. The bank requires a 12 percent compensating balance on these loans. Current account balances would not be available to meet any of this compensating balance requirement.

a. Calculate the cost of not taking a cash discount. (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

b. What is the effective rate of interest on the bank loan? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

c. Do you agree with Duke's proposal?

Answer 1

a. Cost of not taking discount	360/(final due date- discount period)*(discount/(100-discount))
	360/(60-11)*2/100-2
	360/49*0.020
	14.69%
b. Effective rate of interest	Interest Rate/ (1- compensating rate)
	16%/(1-0.12)
	18.18%
c. The effective cost of loan is more than cost of availing the discount, reynolds should continue to pay in 60 days and should not avail discount, no Duke's proposal should not be accepted.