1Your firm purchases goods from its supplier on terms of 141

1.Your firm purchases goods from its supplier on terms of

1.4/10, net 40.

a. What is the effective annual cost to your firm if it chooses not to take the discount and makes its payment on day 40??

b. What is the effective annual cost to your firm if it chooses not to take the discount and makes its payment on day 50?? ?(Hint: Use a? 365-day year.)

2.

Solution

a.

Payment on 40 th day:

Assume the amount is $100

If the firm pays the amount in 10days,it can avail $4 as discount on the amount $100.

If the firm chooses to pay on the 40 th day ,the firm can use the amount of $96 for a further period.

Time period = 40 - 10

= 30 days

Interest for one day = 4/96

= 4.17%

Effective annual cost = (1 + interest rate per day)^{365/no.of days} - 1

= (1.0417)^365/30 – 1

= 1.6439 - 1

= 0.6439 i.e 64.39%

Effective annual cost = 64.39%

b.

Payment on 50 th day:

If the firm delays payment until the 50th day, it has use of the funds for 40 days beyond the discount period.

Effective annual cost = (1 + interest rate per day)^{365/no.of days} - 1

= (1.0417)^365/40 – 1

= 1.4518 - 1

= 0.4518 i.e 45.18%

Effective annual cost = 45.18%