Question

A firm offers terms of 1/10, net 35.

a. What effective annual interest rate does the firm earn when a customer does not take the discount? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

b. What effective annual interest rate does the firm earn if the discount is changed to 2 percent? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

c. What effective annual interest rate does the firm earn if the credit period is increased to 55 days? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

d. What effective annual interest rate does the firm earn if the discount period is increased to 15 days? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Effective annual interest rate = [1 + (Disc.%/100 - Disc.%)]^[365 / (Days Credit Outstanding – Discount Period)] - 1

a. Effective annual interest rate = [1 + (1/99)]^[365 / (35 - 10)] - 1 = 0.1580 or 15.80%

b. Effective annual interest rate = [1 + (2/98)]^[365 / (35 - 10)] - 1 = 0.3431 or 34.31%

c. Effective annual interest rate = [1 + (1/99)]^[365 / (55 - 10)] - 1 = 0.0849 or 8.49%

d. Effective annual interest rate = [1 + (1/99)]^[365 / (35 - 15)] - 1 = 0.2013 or 20.13%