Sue Cole is a new accountant with Simon Company. Simon purchased merchandise on

Question

Sue Cole is a new accountant with Simon Company. Simon purchased merchandise on account for $9,000. The credit terms are 1/10, n/30. Sue has talked with the company's banker and knows that she could earn 6% on any money invested in the company's savings account. Instructions (a) Should Sue pay the invoice within the discount period or should she keep the $9,000 in the savings account and pay at the end of the credit period? Support your recommendation with a calculation showing which action would be best. (b) If Sue forgoes the discount, it may be viewed as paying an interest rate of 1% for the use of $9,000 for 20 days.

Calculate the annual rate of interest that this is equivalent to.

Explanation / Answer

Credit term 1/10, n/30 means if $9000 is paid within 10 days, then a discount of 1% on $9000 would be received by the company. If the company does not pay within 10 days, it has to pay the entire amount of $9000 within 30 days of the purchase of the merchandise.

a) Considering the payment is made on the 10th day, the discount that could be availed by the company

= $9000 * 1% = $90

If the company forgoes the discount and keep the money in the savings account for 20 days, the interest that could be received by the company = (20/360) * 6% * $9000 = $30.

Thus, if Sue opts for keeping the money in the bank account instead of taking the cash discount of 1%, the company would lose $90 - $30 = $60

b) Equivalent annual interest rate = (360/20) * 1% = 18%

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