The Reynolds Corporation buys from its suppliers on terms of 3/16, net 60. Reyno

Question

The Reynolds Corporation buys from its suppliers on terms of 3/16, net 60. Reynolds has not been utilizing the discounts offered and has been taking 60 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 21 percent. The bank requires a 22 percent compensating balance on these loans. Current account balances would not be available to meet any of this compensating balance requirement.  
  
a. 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 = what %

b. What is the effective rate of interest on the bank loan? (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 = what %
  
c. Do you agree with Duke's proposal?

Explanation / Answer

Ans a) Cost of not taking a cash discount=[Discount % / (100% Discount %)] ×[360 / (Final due date Discount period)]

=[3% / (100% 3%)] ×[360 / (60 16)]=.2530,

= 25.30%

Ans b) Effective rate ofinterest= Interest rate / (1 C)

= .21 / (1 .22)= .2692, or 26.92%

Ans c) The effective cost of the loan, 26.92 percent, is greater than the cost of passing up the discount, 25.30percent. Reynolds Corporation should not borrow funds from the bank.

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