Question

A large retailer obtains merchandise under the credit terms of 3/10, net 35, but routinely takes 65 days to pay its bills. (Because the retailer is an important customer, suppliers allow the firm to stretch its credit terms.) What is the retailer's effective cost of trade credit? Assume 365 days in year for your calculations. Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

Discount Rate = 3%
Discount Period = 10 days
Credit Period = 65 days

Effective Cost of Trade = [1 + Discount Rate / (1 - Discount Rate)] ^ [365 / (Credit Period - Discount Period)] - 1
Effective Cost of Trade = [1 + 0.03 / (1 - 0.03)] ^ [365 / (65 - 10)] - 1
Effective Cost of Trade = [1 + 0.03 / 0.97] ^ [365 / 55] - 1
Effective Cost of Trade = 1.030928 ^ 6.636364 - 1
Effective Cost of Trade = 1.2240 - 1
Effective Cost of Trade = 0.2240 or 22.40%

So, retailer's effective cost of trade credit is 22.40%