The Reynolds Corporation buys from its suppliers on terms of 2/17, net 65. Reyno

Question

The Reynolds Corporation buys from its suppliers on terms of 2/17, net 65. Reynolds has not been utilizing the discounts offered and has been taking 65 days to pay its bills. Mr. Duke, Reynolds Corporation vice president, has suggested that the company begin to take the discounts offered. Duke proposes that the company borrow from its bank at a stated rate of 15 percent. The bank requires a 20 percent compensating balance on these loans. Current account balances would not be available to meet any of this compensating balance requirement. Calculate the cost of not taking a cash discount. (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of not taking a cash discount 0 % Calculate the effective rate of interest if the company borrows from the bank. (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Effective rate of interest Do you agree with Duke's proposal? No Yes

Explanation / Answer

a)

N = 65-17 = 48 days

D= 2%

Cost of not taking cash discount = ( d/ (1-d))x365 / n   -1

                                                                = (0.02/ (1-0.02)x365 / 48    -1

                                                                = 0.1552 -1

                                                                = 15.52%

b)

Effective rate of interest = (1+ d/ (1-d))^365 / n   -1

                                                = (1+ 0.02/ (1-0.02)^365 / 48    -1

                                                = 1.1661 -1

                                                = 16.61%

c)

Yes, Duke’s proposal is better.

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