Question

A company wants to approximate the 12% annual interest rate based on a 365-day year it pays on its working capital loan.

Which of the following terms should the company offer its customers?

A) 2.00%, 15, net 45

B) 1.00%, 15, net 45

C) 0.75%, 10, net 30

D) 0.50%, 10, net 30Attribute

Answer 1

Answer is Option B) 1.00%, 15, net 45

The credit term should have an interest rate as close to 12 %, working on each credit terms we find the option B to be closer to 12% and there for the company should offer to its customers  1.00%, 15, net 45 credit terms

Working Notes

Cost of not taking Discount is given as

Cost of not taking Discount = [Disount % / (1- Discount %)] x [365 / (payment days - Discount days)]

Substitung values in the equation of option A

Cost of not taking Discount = [0.02/0.98] x 365/(45-15)

Cost of not taking Discount = 0.0204 x (365/30)

Cost of not taking Discount =0.0204 x12.167

Cost of not taking Discount =24.83%

Substitung values in the equation of option B

Cost of not taking Discount = [0.01/0.99] x 365/(45-15)

Cost of not taking Discount = 0.0101 x (365/30)

Cost of not taking Discount =0.0101 x12.167

Cost of not taking Discount =12.29%

Substitung values in the equation of option C

Cost of not taking Discount = [0.0075/0.9925] x 365/(30-10)

Cost of not taking Discount = 0.00756 x (365/20)

Cost of not taking Discount =0.00756 x18.25

Cost of not taking Discount =13.80%

Substitung values in the equation of option D

Cost of not taking Discount = [0.005/0.995] x 365/(30-10)

Cost of not taking Discount = 0.005025 x (365/20)

Cost of not taking Discount =0.005025 x18.25

Cost of not taking Discount =9.17%