Question

The D.J. Masson Corporation needs to raise $600,000 for 1 year to supply working capital to a new store. Masson buys from its suppliers on terms of 1/10, net 75, and it currently pays on the 10th day and takes discounts. However, it could forgo the discounts, pay on the 75th day, and thereby obtain the needed $600,000 in the form of costly trade credit. What is the effective annual interest rate of this trade credit? Assume a 365-day year. Do not round intermediate calculations. Round your answer to two decimal places.

Grunewald Industries sells on terms of 2/10, net 40. Gross sales last year were $4,891,000 and accounts receivable averaged $469,000. 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 of trade credit: % Effective cost of trade credit

Answer 1

Solution to Question-1:

The effective annual interest rate of this trade credit = (Discount % /100-Discount %)* 365/(Credit Period – Discount Period)

= {1/(100 -1)} * {365/(75-10)}

= (1/99) * (365/65)

= 0.0101010 * 5.615384615

= 0.0567

= 5.67%

.

.

Solution to Question-2:

Sale per day = $4,891,000/365

= $13,400

Discount Sale = 0.5 * $13,400

                     = $ 6,700

Account Receivable Attributable to discount customers = $ 6,700 * 10

                          = $ 67,000

Account Receivable Attributable to non-discount customers :

Total Account $ $469,000

Discount customers Account Receivable $ 67,000

Non discount customers Account Receivable $ 4,02,000

Alternatively,

DSO = $ 469,000 / $ 13,400 = 35 days

35 = 0.5(10) + 0.5 ( DSO non discount )

DSO non discount = 30/0.5 = 60 days

Thus, although non discount customers are supposed to pay within 40 days, they are actually paying, on average in 60 days

Cost of trade credit to non-discount customer equals the rate of return to the firm.

Nominal rate = 0.0204(7.3)

                   = 14.90%

Effective Cost = (1+2/98)365/50 - 1

                    = 15.89%