Grunewald Industries sells on terms of 2/10, net 40. Gross sales last year were
ID: 2714980 • Letter: G
Question
Grunewald Industries sells on terms of 2/10, net 40. Gross sales last year were $4,562,500 and accounts receivable averaged $437,500. Half of Grunewald’s customers paid on the 10th day and took discounts. What are the nominal and effective costs of trade credit to Grunewald’s nondiscount customers? (Hint: Calculate sales/day based on a 365-day year, then calculate average receivables of discount customers, and then find the DSO for the nondiscount customers.) Please show the working. The answers in the book are Nominal cost = 14.90% and Effective Cost = 15.89%
Explanation / Answer
Sale per day = $ 12,500
Discount Sale = 0.5 ( $12,500 )
= $ 6,250
Account Receviable Attributable to discount customers = $ 6,250(10)
= $ 62,500
Account Receivable Attributable to non discount customers :
Total Account $ 437,500
Discount customers Account Receivable $ 62,500
non discount customers Account Receivable $ 375,000
Alternatively,
DSO = $ 437,500 / $ 12,500 = 35 days
35 = 0.5(10) + 0.5 ( DSO non discount )
DSO non discount 30/0.5 = 60 days
Thus, although non discount customers are supposed to pay within 40 days, they are actually paying, on average in 60 days
Cost of trade credit to non discount customer equals the rate of return to the firm.
Nominal rate = 0.0204(7.3)
= 14.90%
Effective Cost = (1+2/98)365/50 - 1
= 15.89%
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