The Reynolds Corporation buys from its suppliers on terms of 3/17, net 65. Reyno

Question

The Reynolds Corporation buys from its suppliers on terms of 3/17, 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 22 percent. The bank requires a 8 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 cash discount____%  

    

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 ____%

Explanation / Answer

1) Cost of not taking a cash discount Cost of not taking a cash discount =( Discount % /(100% -Discount%)) x 360/Final due date - Discount period Cost of not taking a cash discount =( 3% /(100% -3%)) x 360/65 - 17 23.20% 2) Effective rate of interest with a 8% compensating balance requirement: Effective Rate of Interest = Interest rate/(1 – C) Effective Rate of Interest = 22%/(1 – 8%) 23.91% The effective cost of the loan, 23.91%, is more than the cost of passing up the discount, 23.20%. Reynolds Corporation should continue to pay in 65 days and pass up the discount.

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