Question
In: Finance
The Reynolds Corporation buys from its suppliers on terms of 2/11, net 60. Reynolds has not...
The Reynolds Corporation buys from its suppliers on terms of 2/11, net 60. Reynolds has not been utilizing the discounts offered and has been taking 60 days to pay its bills. Ms. Duke, Reynolds Corporation's vice president, has suggested that the company begin to take the discounts offered. Duke proposes that the company borrow from its bank at a stated rate of 16 percent. The bank requires a 12 percent compensating balance on these loans. Current account balances would not be available to meet any of this compensating balance requirement.
a. Calculate the cost of not taking a cash discount. (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
b. What is the effective rate of interest on the bank loan? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
c. Do you agree with Duke's proposal?
Solutions
Expert Solution
Based on the given data, pls find below workings:
For the sake of calculations, have assumed Amount as $ 100000
| Fund Requirement | 1,00,000 | |||
| Alternative 1- Cash Discount | Alternative 2- Loan | |||
| Cash Discount Terms | 2/11, Net 60 | Loan Amount | 1,00,000 | |
| Reqd Compensating Balance | 12% | |||
| Left out Period | ||||
| (60-11) | 49 | APR | 16% | |
| Total No. of Days | 360 | Interest Cost | 16,000 | |
| No.of Times | 7.35 | |||
| Discount Cost | 14,694 | Total Finance Cost | 16,000 | |
| Effective Rate | 14.69% | Effective Rate | 18.18% | |
| Alternative 1 | 14.69% | |||
| Alternative 2 | 18.18% | |||
Ms Duke's proposal for the company to take the discounts being offered seems fair, as the the effective rate is much lower than that of availing Loan.
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