Question

Northeast Baptist buys $500,000 of a particular item (at gross prices) from its major supplier, Cardinal Health, which offers NE Baptist terms of 3/20, net 60. Currently, the hospital is paying the supplier the full amount due on Day 60, but it is considering taking the discount, paying on Day 20 and replacing the trade credit with a bank loan that has a 12 percent rate.
Required:
. a. What is the amount of free trade credit that Baptist obtains from Cardinal Health? (Assume 360 days per year throughout this problem.)b. What is the amount of costly trade credit?c. What is the approximate annual cost of the costly trade credit?d. Should Baptist replace its trade credit with the bank loan? Explain your answer.e. If the bank loan is used, how much of the trade credit should be replaced?

Answer 1

Answer:

a) 10,000 free trade credit

b) Costly trade    6.466,67

c)    yearly cost  38,800

d) Yes as the total cash outflow to purchase the goods is lower using costly trade

e) The complete amount as it reduces the cashflow needed for the acquisition of the goods

Explanation:

principal x rate x time = interest

Where rate and time should be expressed in the same metric thus, we express the 60 days as portion of a year

500,000 x 0.12 x 60/360 = 10,000 free trade credit

costly trade:

500,000 x 0.97 = 485,000

485,000 x 0.12 x 40/360 = 6.466,67

cost per year: the cicle repeats every 60 days thus, 6 times per year:

6,466.67 x 6 = 38.800‬

total financial outflow:

with free credit: 500,000

with costly trade: 485,000 + 6,466.67 = 491.466,67‬

As the costly trade generated a lower cash flow it should take this path