gutter company buys on terms of 1/10 Gutter Company buys on terms of 1/10, net 4
ID: 2725577 • Letter: G
Question
gutter company buys on terms of 1/10 Gutter Company buys on terms of 1/10, net 40, but it has not been taking discounts and has actually been paying in 64 days rather than 40 days. Gutter's balance sheet follows (thousands of dollars): "Stated net of cash discounts. Gutter's suppliers are threatening to stop shipments unless the company begins making prompt payments (that is, paying in 40 days or less). The firm can borrow on a one-year note from its bank at a rate of 10 percent, discount interest, with a 20 percent compensating balance required. (Gutters's $40,000 of cash cannot be used as part of the compensating balance.) Determine what action Gutter should take by calculating (a) the cost of non-free trade credit and (b) the cost of the bank loan.Explanation / Answer
Cost of non-free trade credit = discount/(100-discount) x 365/(days paid after purchase - days of discount period)
= > 1/(100-1) x 365/(64-40) = 0.1536 or 15.36%
Loan required = $720,000 (Accounts payable)
Interest rate = 10%
Nominal Interest = $72,000
Compensating Balance = $720,000 x 20% = $144,000
So, the cost of the bank loan = $72,000 / ($720,000 - $144,000) = 0.125 or 12.5%
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