Question

Your opportunity cost is 7.6 % and you are given the following 3 credit terms from your suppliers. Determine the implicit interest rate (opportunity cost) of each discounted terms and determine which discounts you will take based upon the terms and opportunity cost of funds.

2/10 net 45

1/5 net 60

.5/10 net 30

Answer 1

1. Cost of trade = Discount % / ( 1 - Discount%) * [ 360 / ( Full alowed payment days - Discount days)]

Option 1 : 2% / ( 1 - 2%) * [ 360 / ( 45 - 10)]

= 0.02 / 0.98 * ( 360 / 35)

= 0.20991 or 20.991%

Option 2 : 1% / ( 1 - 1%) * [ 360 / ( 60 - 5)]

= 0.01 / 0.99 * ( 360 / 55)

= 0.066115 or 6.6115%

Option 3 : 0.50% / ( 1 - 0.5%) * [ 360 / ( 30 - 10)]

= 0.005 / 0.995 * ( 360 / 20)

= 0.090452 or 9.0452%

The Opportunity cost of Option A is highest so we should take this discount from the seller and also it is greater than estimated cost of capital.