Question

Consider trade credit as an unsecured source of financing. Recall we talked about it during our very first webinar. In summary, trade credit arises spontaneously when the firm purchases some merchandise from a supplier and then receives an invoice with a cash discount for early payment. In this exercise all I want from you is to create a financial model using excel studying various aspects of trade credit as a flexible source of short-term financing available to the firm. In your MS Excel file you might want to discuss about:

the APR (effective cost) of the trade credit.

The overall cost should also be discussed.

Here are the assumptions related to the invoice: The invoice balance is $450,000. The terms of the invoice is 3/45, net 90. Attach an Excel file with your financial model in it. At the minimum you should discuss and produce the two numbered items above. In addition you might want to investigate another aspect of trade credit as well. Please consider what else can be analyzed with your financial model.

Answer 1

Effective cost of trade credit = (1+(%discount/100%-%discount))^(365/(Credit period-discount days)) - 1

% discount = 3

Credit period =90

discount days = 45

Effective cost of trade credit = (1+(3/100-3))^(365/(90-45)) - 1

Effective cost of trade credit = (1+ 3/97)^(365/45) -1

Effective cost of trade credit = 1.28025 -1 = 0.28025 = 28.03%

Effective cost of trade credit = 28.03%

Since the invoice balance is 450,000, we can say the overall cost would be 28.03% of 450,000 = 28.03%*450,000 = $126,135

Overall cost would be $126,135

Next, we can also calculate the cost of not taking the credit =discount %/(100-discount %) * 365/(credit - discount days) = 3/(100-3)*365/(90-45) = 3/97*365/45 = 25.09%