What would be the firm’s nominal and effective costs of not taking discounts if it could stretch its payments to 40 days?

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What would be the firm’s nominal and effective costs of not taking discounts if it could stretch its payments to 40 days?

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Suppose a firm makes purchases of $3.65 million per year under terms of 2/10, net 30, and takes discounts.
a. What is the average amount of accounts payable net of discounts? (Assume the $3.65 million of purchases is net of discounts—that is, gross purchases are $3,724,489.80, discounts are $74,489.80, and net purchases are $3.65 million.)

Suppose a firm makes purchases of $3.65 million per year under terms of 2/10, net 30, and takes discounts.
b. Is there a cost of the trade credit the firm uses?

Suppose a firm makes purchases of $3.65 million per year under terms of 2/10, net 30, and takes discounts.
c. If the firm did not take discounts but did pay on the due date, what would be its average payables and the nominal and effective costs of this nonfree trade credit?

Suppose a firm makes purchases of $3.65 million per year under terms of 2/10, net 30, and takes discounts.
d. What would be the firm’s nominal and effective costs of not taking discounts if it could stretch its payments to 40 days?

Answer & Explanation (4)

part d

Explanation

discount percentage =2%
Days credit outstanding = 40 days
Discount period =10 days
Nominal annual cost of trade credit = Discount percentage/ (100-Discount percentage) *365/(Days credit is outstanding - Discount period)
Nominal cost of trade credit =2/98*365/(40-10)
=0.0204*12.17
=0.2483
=24.83%
in effective annual terms cost of trade credit =(1+periodic rate)^(period/year)-1
periodic rate = Discount percentage /(100-Discount percentage)
Period/year =365/(days credit is outstanding -Discount period)
Periodic rate =2/98 =0.0204
period/year =365/(40-10) =12.17
Effective cost of trade credit =(1.0204)^12.17-1.0
=0.2786
=12.86%

Answer

Nominal Rate = (2/98) * 365/(40-10) = 24.83%
Effective Cost = (1 + 2/98 ) 365/30 - 1 = 27.86%

part c

Explanation

Average payables = 3,650,000 / 365 x 30 = $300,000
Nominal cost = (2 / 98) x (365/(30-10)) = 0.3724489796 = 37.24%
Effective cost = (1+(2/98))365/20 - 1 = 0.4458529273 = 44.59%

Answer

Answers
Average payables = $300,000
Nominal cost = 37.24%
Effective cost = 44.59%

part b

Explanation

There is NO cost of the trade credit . Firm is using FREE Trade Credit at this point.

Answer

No.

part a
swer

Answer : $100,000
Working :
Average amount of Accounts Payable = (Yearly Accounts Payable (Net of discount) / days in a year) * days till which discount available
=($3,650,000/365) * 10 days = $10,000 * 10 days = $100,000

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