Problem 16-10 Effective Cost of Trade Credit The D.J. Masson Corporation needs t
ID: 2717868 • Letter: P
Question
Problem 16-10
Effective Cost of Trade Credit
The D.J. Masson Corporation needs to raise $700,000 for 1 year to supply working capital to a new store. Masson buys from its suppliers on terms of 3/10, 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 $700,000 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
3/10, net 90 ,means D.J. Massion Corporation can either pay $700000*97%= $ 679000 at the end of 10 days discount period , or wait for 90 days and pay amount $ 700000 by fogoing discount.
Cost of Credit =[ Percent Discount /(100-Percent Discount )] * [365 /(credit period-discount Period)]
=[3/(100-3)] *[(365/90-10)]
=14.11 %
Now,
Effective annual interest rate = (1+cost of credit /n)^n -1
= (1+0.1411/4.5625)^4.5625-1
= 14.91 %
where,
n= number of compoundings period=365/80days= 4.5625