Question

Problem 16-03
Cost of Trade Credit

What are the nominal and effective costs of trade credit under the credit terms of 1/20, net 40? Assume 365 days in a year for your calculations. Round your answers to two decimal places. Do not round intermediate calculations.

Nominal cost of trade credit	%
Effective cost of trade credit	%

Problem 16-04
Cost of Trade Credit

A large retailer obtains merchandise under the credit terms of 2/15, net 40, 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

Ans:- (a) Under the credit terms of 1/20 net 40 and assuming 365 days in a year we have to calculate the Nominal cost of trade credit and effective cost of Trade credit. Here 1/20 net 40 means 1% discount will be allowed if the bill is paid within 20 days otherwise the total amount should be paid within 40 days.

Nominal Cost of Trade Credit will be given by

Discount Percentage /(1 - Discount Percentage) * 365/ (Total Payment Period - Discount Period)

= 0.01/(1-0.01)* 365/(40-20) = 0.1843 = 18.43%.

The effective cost of Trade Credit will be given by

(1+ (Discount Percentage/(1 - Discount Percentage))) ^ (365/(Total Pay period - Discount Days)) -1

= (1 +( 0.01/(1-0.01)))^ (365/(40-20)) - 1 =0.02013 =  20.13%.

Ans: - (b) As per question the credit terms are given 2/15 net 40 but the retailer routinely takes 65 days to pay its bill.

Therefore, the retailer's effective cost of trade credit will be given by

(1+( Discount Percentage/(1- Discount Percentage)))^(365/( Days allowed - Discount days)) - 1

(1+( 0.02/( 1-0.02)))^(365/(65-15) -1 = 0.1589 = 15.90%.