Question

Howes inc. purchases $4,562,500 in goods per year from its sole supplier on terms of 2/15, net 50. if the firm chooses to pay on time but does not take the discount, what is the effective annual percentage cost of its non-free trade credit? (assume a 365-day year.)?

Answer 1

Answer: The cost of non-free trade credit is 23.45%

We follow these steps to arrive at the answer

We have:

Discount Rate     2%

First we find $\frac{Discount Rate}{1 - Discount Rate}$.

$\frac{Discount Rate}{1 - Discount Rate} = \frac{0.02}{1 - 0.02}$

$\frac{Discount Rate}{1 - Discount Rate} = \frac{0.02}{0.98} = 0.020408163$

Adding 1 to the number above we get 1.020408163

Next we'll find the number of extra credit days after the discount period.

$Extra credit days = Total credit days - Discount period$

$Extra credit days = 50 - 15 = 35 days$

Next we need to raise 1.020408163  to the fraction of 365/35. We get

$1.020408163^{ 365/35} = 1.234523883$

Finally we need to deduct 1 from the number above to get $1.234523883 -1 = 0.234523883$

We express the number above as a percentage to arrive at the cost of non-free trade credit.