Question

Calculate the effective cost of the following trade credit terms when payment is made on the net due date. Use approximate​ cost-of-credit formula. Note​: Assume a​ 30-day month and​ 360-day year.

a. 4​/5​, net 45

b. 4​/10​, net 30

c. 3​/10​, net 60

d. 4​/10​, net 60

Answer 1

Sol:

APR of the credit terms = Discount% / (100 - Discount%) x 360 / (Full allowed payment days - Discount days)   

a) 4​/5​, net 45 - The credit term of [4​/5​, net 45] means that you will get a discount of 4% if you clear your account within 5 days with a maximum credit period of 45 days.

APR of the credit terms = 4% / (100 - 4%) x 360 / (45 - 5)

APR of the credit terms = (4% / 96%) x (360 / 40)

APR of the credit terms = 0.04167 x 9 = 0.375 or 37.5%

b) 4​/10​, net 30 - The credit term of [4​/10​, net 30] means that you will get a discount of 4% if you clear your account within 10 days with a maximum credit period of 30 days.

APR of the credit terms = 4% / (100 - 4%) x 360 / (30 - 10)

APR of the credit terms = (4% / 96%) x (360 / 20)

APR of the credit terms = 0.04167 x 18 = 0.75 or 75%

c) 3​/10​, net 60 - The credit term of [3​/10​, net 60] means that you will get a discount of 3% if you clear your account within 10 days with a maximum credit period of 60 days.

APR of the credit terms = 3% / (100 - 3%) x 360 / (60 - 10)

APR of the credit terms = (3% / 97%) x (360 / 50)

APR of the credit terms = 0.03093 x 7.2 = 0.2227 or 22.27%

d) 4​/10​, net 60 - The credit term of [4​/10​, net 60] means that you will get a discount of 4% if you clear your account within 10 days with a maximum credit period of 60 days.

APR of the credit terms = 4% / (100 - 4%) x 360 / (60 - 10)

APR of the credit terms = (4% / 96%) x (360 / 50)

APR of the credit terms = 0.04167 x 7.2 = 0.30 or 30%