Question

A large retailer obtains merchandise under the credit terms of 1/20, net 30, but routinely takes 50 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

Retailer's Effective Cost of Trade Credit

Here, we’ve Discount Rate = 1%

Normal Credit Period = 50 Days

Discount Period = 20 Days

Number of days in a year = 365 Days

Effective cost of Trade Credit = [1 + {Disc. % / (100% - Disc. %)}]^ ^{{365 Days / (Credit Period – Discount Period)}} – 1

= [1 + {0.01 / (1 – 0.01)}]^ ^{[365 Days / (50 Days – 20 Days)]} – 1

= [1 + (0.01 / 0.99)]^ ^{[365 / 30]} – 1

= [1 + 0.010101] ^ ^12.166667 – 1

= 1.130069445 – 1

= 0.130069445 or

= 13.01% (Rounded to 2 decimal place)

“Hence, The Retailer's effective cost of trade credit will be 13.01%”