Slipshod Machine Tool Co. owes $55,000 to one of its suppliers. The supplier has

Question

Slipshod Machine Tool Co. owes $55,000 to one of its suppliers. The supplier has offered a trade discount of 2/10 net 30. Slipshod can borrow the funds from either of two banks: First City Bank will loan the funds for 20 days at a cost of $500; Upstart Bank offers a discounted loan for 20 days at a cost of $375.

a) What is the cost of failing to take the discount?
b) What is the effective interest rate on each of the loans?
c) Should Slipshod take the cash discount?
d) Which bank loan should Slipshod use?

Explanation / Answer

a) What is the cost of failing to take the discount? The cost of failing to take the discounts is the amount of the trade discount which is: Trade Discount = $40,000 x 2% = $800 b) What is the effective interest rate on each of the loans? First Citibank: $400 / $40,000 x 365 / 20 = 18.25% Upstart Bank: $320 / ($40,000 - $320) x 365 / 20 = 14.72% c.) Which alternative should slipshod follow? Upstart Bank's offer is the best alternative because it has lower effective interest rate.

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