Question

Newsome Inc. buys on terms of 4/10, net 45. It does not take the discount, and it generally pays after 55 days. What is the effective (not nominal) annual percentage cost of its non-free trade credit, based on a 365-day year? Enter your answer rounded to two decimal places. Do not enter % in the answer box. For example, if your answer is 0.12345 or 12.345% then enter as 12.35 in the answer box.

Answer 1

Solution :

The formula for calculating the Effective annual percentage Cost of non free Trade Credit is

= ( 1 + [Discount rate / (1 – Discount Rate )] ) ⁿ – 1

Where n= No. of days in a period / ( Total payment Period – period for which discount has been offered)

As per the information given in the question we have :

Discount rate = 4 %

Discount period = 10 days

Total payment Period = 55 days ; Period for which discount has been offered = 10 days

Total payment Period – period for which discount has been offered = 55 – 10 = 45 days

Applying the above values in the formula we have

= ( 1 + (0.04 / (1 – 0.04)) ^(365/45)   - 1                            

= ( 1 + (0.04 / 0.96)) ^(8.1111)   - 1                                      

= ( 1 + 0.041667 ) ^{( 8.1111 )}   - 1                                         

= ( 1.041667 ) ^{( 8.1111 )}   - 1

= 1.392519 – 1

= 0.392519

= 39.2519 %                                                                                      

= 39.25 % ( when rounded off to two decimal places )

Thus the Effective annual percentage Cost of non free Trade Credit is = 39.25 %