Question

Bankston Feed and Supply Company buys on terms of 1/10, net 30, but it has not been taking discounts and has actually been paying in 60 rather than 30 days. Now Bankston’s suppliers are threatening to stop shipments unless the company begins making prompt payments (30 days). The firm can borrow on a one-year note from its bank at a rate of 15%, discount interest, with a 20% compensating balance required.   
a. Determine what action Bankston should take by calculating the effective rates of both alternatives. You can use approximate formula for trade credit.
b. Assume that Bankston forgoes discounts, and then borrows the amount needed to service $250,000 in payables. How much will Bankston actually have to borrow? Show work.

Answer 1

a]	Effective rate of trade credit [with 30 days limit) = (1+1/99)^(365/20)-1 =	20.13%
	Bank Credit:
	Amount to be borrowed for $100 = 100/((1-(15%+20%) =	$              153.85
	Amount repayable = 153.85*(1-20%) =	$              123.08
	Effective interest rate = 123.08/100-1 =	23.08%
	Bankston should avail of trade credit; should not go for
	bank loan.
b]	Bankston will have to borrow = 250000/(1-35%) =	$          3,84,615