You start work at a new firm and learn that it\'s company policy to never take a

Question

You start work at a new firm and learn that it's company policy to never take a trade discount. When you ask your boss about this, she says the firm needs the trade credit to avoid borrowing more money. You tell her it would be cheaper to borrow than to miss taking the discounts. She tells you to prove it. You learn that most of your suppliers offer terms of 1/10, net 30. Assume the firm's cost of borrowed funds is 18%. Use a 365-day year.

a) Compute the effective interest rate of the trade discount.

b) Compute the annual percentage rate of the trade discount.

c) Should the company take the trade discount?

Explanation / Answer

Answer:a) Calculation of the effective interest rate of the trade discount:

[discount / (1-discount)] * [365 / (final date - early date)]

=($0.01/$0.99)*[(1/20/365)]=0.18434

Answer:b) (0.18/0.82)*(365/20)=4.000

Answer:c) Yes,the company should take the trade discount because cost of financing is less than interest rate.

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