Problem 16-10 Effective Cost of Trade Credit The D.J. Masson Corporation needs t
ID: 2383836 • Letter: P
Question
Problem 16-10
Effective Cost of Trade Credit
The D.J. Masson Corporation needs to raise $400,000 for 1 year to supply working capital to a new store. Masson buys from its suppliers on terms of 1/10, net 90, and it currently pays on the 10th day and takes discounts. However, it could forgo discounts, pay on the 90th day, and get the needed $400,000 in the form of costly trade credit. What is the effective annual interest rate of this trade credit? Assume 365 days in year for your calculations. Do not round intermediate calculations. Round your answer to two decimal places.
%
Explanation / Answer
Answer:
Accounts payable:
Nominal cost = (1/99)(365/80)=(0.01010)(4.5625)=4.61%
EAR cost = (1.01010)4.5625 - 1.0 = 4.69%.
Bank loan:
0 1
400,000 -400,000
-12,000 (discount interest)
388,000
With a financial calculator, enter N = 1, PV = 388000, PMT = 0, and FV = -400000 to solve for I = 3%
Note that, if Masson actually needs $400,000 of funds, he will have to borrow 400000/1-0.03 =$412371.13 The effective interest rate will still be 3 percent.
The bank loan is the lowest cost source of capital available to D.J. Masson at 3 percent.