Question

Cost of Trade Credit

What are the nominal and effective costs of trade credit under the credit terms of 2/20, net 30? Assume a 365-day year. Do not round intermediate calculations. Round your answers to two decimal places.

Nominal cost of trade credit: %

Effective cost of trade credit: %

Answer 1

Discount Rate = 2.00%
Discount Days = 20 days
Credit Days = 30 days

Nominal Cost of Trade Credit = [Discount Rate / (1 - Discount Rate)] * [365 / (Credit Days - Discount Days)]
Nominal Cost of Trade Credit = [0.02 / (1 - 0.02)] * [365 / (30 - 20)]
Nominal Cost of Trade Credit = [0.02 / 0.98] * [365 / 10]
Nominal Cost of Trade Credit = 0.020408 * 36.50
Nominal Cost of Trade Credit = 0.7449 or 74.49%

Effective Cost of Trade Credit = [1 + Discount Rate / (1 - Discount Rate)]^[365 / (Credit Days - Discount Days)] - 1
Effective Cost of Trade Credit = [1 + 0.02 / (1 - 0.02)]^[365 / (30 - 20)] - 1
Effective Cost of Trade Credit = [1 + 0.02 / 0.98]^[365 / 10] - 1
Effective Cost of Trade Credit = 1.020408^36.50 - 1
Effective Cost of Trade Credit = 2.0905 - 1
Effective Cost of Trade Credit = 1.0905 or 109.05%