Question

A firm offers terms of 1.8/10, net 30.

  

a.	What effective annual interest rate does the firm earn when a customer does not take the discount? (Use 365 days a year. 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 terms are changed to 2.8/10, net 30, and the customer does not take the discount? (Use 365 days a year. 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 terms are changed to 1.8/10, net 60, and the customer does not take the discount? (Use 365 days a year. 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 terms are changed to 1.8/15, net 30, and the customer does not take the discount? (Use 365 days a year. Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

    

Answer 1

Effective Cost of Trade Credit = [1 + (Disc.%/100 - Disc.%)]^[365 / (Days Credit Outstanding – Discount Period)] - 1

a. Effective cost of trade credit = [1 + (1.8/98.2)]^[365 / (30 - 10)] - 1 = 0.3930 or 39.30%

b. Effective cost of trade credit = [1 + (2.8/97.2)]^[365 / (30 - 10)] - 1 = 0.6792 or 67.92%

c. Effective cost of trade credit = [1 + (1.8/98.2)]^[365 / (60 - 10)] - 1 = 0.1418 or 14.18%

d. Effective cost of trade credit = [1 + (1.8/98.2)]^[365 / (30 - 15)] - 1 = 0.5558 or 55.58%