Lamar Lumber buys $8 million of materials (net of discounts) on terms of 3/5, ne

Question

Lamar Lumber buys $8 million of materials (net of discounts) on terms of 3/5, net 80; and it currently pays after 5 days and takes discounts. Lamar plans to expand, which will require additional financing. Assume 365 days in year for your calculations.

If Lamar decides to forgo discounts, how much additional credit could it obtain? Round your answer to two decimal places?

$ ?

What would be nominal cost of that credit? Round your answer to two decimal places

? %

What would be the effective cost of that credit? Round your answer to two decimal places

? %

If the company could get funds from a bank at a rate of 7% interest paid monthly, based on a 365-day year, what would be the effective cost of the bank loan. Round your answer to two decimal places.

? %

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Part A:

Additional Credit = Cost of Material*((80 - 5)/365) = 8000000*((80-5)/365) = 1643835.62

Part B:

Nominal Cost of Trade Credit = [Discount Percentage/ (1 - Discount Percentage) ]*[365Days / (Credit Outstanding Period - Discount Period)] = 3%/(1-3%)*365/(80 - 5) = 15.05%

Part C:

Effective Cost of Credit = (1 + Cost per Period) ^ Number of Periods) - 1

Cost per Period = Discount Percentage / (1 - Discount Percentage) = 3%/(1-3%) = 3.09%

Number of Periods = 365 days / (Number of Credit Days Outstanding - Discount Period) = 365/(80 - 5) = 4.87 periods

Effective Cost of Credit = (1+3.09%)^4.87 - 1 = 15.96% (it can be 15.98% also, there can be a slight difference on account of rounding off)

Part D:

Effective Cost of Bank Loan = (1+r)^n = (1+7%/12)^12 -1 = 7.23%

Thanks.

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