Question

Grunewald Industries sells on terms of 1/10, net 30. Gross sales last year were $4,342,000 and accounts receivable averaged $475,000. Half of Grunewald's customers paid on the 10th day and took discounts. What are the nominal and effective costs of trade credit to Grunewald's nondiscount customers? (Hint: Calculate daily sales based on a 365-day year, calculate the average receivables for discount customers, and then find the DSO for the nondiscount customers.) Do not round intermediate calculations. Round your answers to two decimal places.

Nominal cost
Effective cost

Answer 1

Solution :- First you need to know the means of 1/10 net 30 This means if a customer makes the payment with in 10 days he will get a discount benefit of 1%

First we need to find Daily sales :- Annual Sales / Total Days = 4342000 / 365 = $11895.89

Discounted sales = 50% of 11895.89 = $5947.95

Accounts Receivables attributable to discounted customers = Discounted Sales per day * Discount Period

= $5947.95 * 10 = $59479.45

Accounts Receivables attributable to non discounted customers = 475000 - 59479.45 = $469052.05

Now

DSO (Daily sales outstanding ) = 475000 / 11895.89 = 39.93

39.93 = 0.50(10) + 0.50(DSO non discount)

DSO non Discount = 34.93 / 0.50 = 69.86

Days after discount period for Non Discounted customers = 69.86 - 10 = 59.86

Nominal cost of Trade Credit = [ Dis%/(100 - Dis%) ] * [365/Day after Dis. Period]

= [1/99]*[365/59.86] = 0.0101*6.097 = 6.159%

Now Effective cost of Trade = [ 1 + Dis/(100- Dis)]^{365/Days after dis. Period} - 1

= [ 1 + (1/99) ]^6.097 - 1

= [ 1.0101 ]^6.097 - 1 = 1.063991 - 1 = 0.06399 = 6.399%