Question

Cash Discounts

Suppose a firm makes purchases of $3 million per year under terms of 3/10, net 30, and takes discounts. Assume 365 days in a year for your calculations. Do not round intermediate calculations.

1. What is the average amount of accounts payable net of discounts? (Assume that the $3 million of purchases is net of discounts - that is, gross purchases are $3,092,784, discounts are $92,784, and net purchases are $3 million.) Round your answer to the nearest dollar.
   $   
   
2. Is there a cost of the trade credit the firm uses?
   I. The cost of the trade credit is $246,575.
   II. There is no cost of trade credit at this point. The firm is using "free" trade credit.
   
3. If the firm did not take discounts but it did pay on the due date, what would be its average payables? Round your answer to the nearest dollar.
   $   
   If the firm did not take discounts but it did pay on the due date, what would be its nominal cost? Round your answer to two decimal places.
        %
   If the firm did not take discounts but it did pay on the due date, what would be its effective cost? Round your answer to two decimal places.
        %
   
4. What would the firm's cost of not taking discounts be if it could stretch its payments to 36 days? Round your answers to two decimal places.

   Nominal cost	%
   Effective cost	%

Answer 1

ANSWER

Average amount of accounts payable net off discounts is as follows:

Purchases made net of discounts=$3 million

Average amount of accounts payable net of discounts = Accounts payable net of discounts/Number of days in a year

=$3,000,000/365

=$8,219.18.*10 days

=$82,191.8.

The firm is using cost free trade credit.

Answer for question no.2:

Average accounts payable if discount is not taken =Accounts payable per day*Number of days payment is made.

=($3,092,784/365)*30

=$254,201.42

Answer for question no.3:

Nominal cost of not taking credit= (3/97)*(365/20)

=56.44%.

Answer for question no.4:

effective cost =(1+(.03/.97))^365/20)-1

=74.34%.

Answer for question no.5:

Nominal cost if the payments are made 36 days.

Nominal cost of not taking credit= (3/97)*(365/26)

=43.42 %

Effective cost=(1+(.03/.97))^(365/26)-1

=53.36%.

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