Question

Cost of Trade Credit Calculate the nominal annual cost of nonfee trade credit under each of the following terms. Assume that payment is made either on the discount date or on the due date. 1/10 net 20; 2/10 net 60; 3/10 net 45; 2/10 net 45; 2/10 net 40

Answer 1

Nominal annual cost of nonfee trade credit

The nominal annual cost of nonfee trade credit is calculated by using the following formula

Nominal cost of credit = [Discount Rate – (100% - Discount Rate)] x [365 Days / (Normal Credit Days – Period Under Discount)]

(a)-For 1/10 net 20;

Nominal cost of credit = [Discount Rate – (100% - Discount Rate)] x [365 Days / (Normal Credit Days – Period Under Discount)]

= [1 / 99] x [365 / (20 – 10)]

= 0.3687 or

= 36.87%

(b)-For 2/10 net 60;

Nominal cost of credit = [Discount Rate – (100% - Discount Rate)] x [365 Days / (Normal Credit Days – Period Under Discount)]

= [2 / 98] x [365 / (60 – 10)]

= 0.1490 or

= 14.90%

(c)-For 3/10 net 45;

Nominal cost of credit = [Discount Rate – (100% - Discount Rate)] x [365 Days / (Normal Credit Days – Period Under Discount)]

= [3 / 97] x [365 / (45 – 10)]

= 0.3225 or

= 32.25%

(d)-For 2/10 net 45;

Nominal cost of credit = [Discount Rate – (100% - Discount Rate)] x [365 Days / (Normal Credit Days – Period Under Discount)]

= [2 / 98] x [365 / (45 – 10)]

= 0.2128 or

= 21.28%

(e)-For 2/10 net 40

Nominal cost of credit = [Discount Rate – (100% - Discount Rate)] x [365 Days / (Normal Credit Days – Period Under Discount)]

= [2 / 98] x [365 / (40 – 10)]

= 0.2483 or

= 24.83%