Question

What are the nominal and effective costs of trade credit under the credit terms of 4/10, net 30? Assume a 365-day year. Do not round intermediate calculations. Round your answers to two decimal places.

Nominal cost of trade credit:

Effective cost of trade credit:

Answer 1

a. Calculation of Nominal cost of the 4/10, net 30.

The trade credit term of 4/10, net 30, means that a 4% discount will be given if payment is made within 10 days. The total amount is due in 30 days. Payment made after10th day and before 30th day, and then otherparty have to pay a penalty of 4%. The penalty is for delayed payment from 10th to 30th day. Delay period of 20 days.

So, if given term is 4/10, net 30,

Discount % = 4%

Final due date = 30 days

Discount period = 10 days

Delay period = 20 days

Note: Total number of days in a year is taken as 360.

Nominal cost of trade credit

= [Discount % / (100% - Discount %)] X [Total number of days inyear / (Final due date- Discount period)]

= [4% / (100% - 4%)] X [360 / (30 - 10 days)]

= [4% / 96%] X [360 / 20]

= 4.167% X 18

= 75%

(b) Effective cost of trade credit =(1+ [Discount % / (100% - Discount %)]^ [Total number of days inyear / (Final due date- Discount period)]) -1 =(1+ [4% / (100% - 4%)]^[360 / (30 - 10 days)]) -1 = ((1.04167)^18) - 1 = 2.0852 - 1 = 108.52%