Langley Clinics, Inc., buys $400,000 in medical supplies a year (at gross prices
ID: 2821566 • Letter: L
Question
Langley Clinics, Inc., buys $400,000 in medical supplies a year (at gross prices) from its major supplier, Consolidated Services, which offers Langley terms of 2.5/10, net 45. Currently, Langley is paying the supplier the full amount due on Day 45, but it is considering taking the discount, paying on Day 10, and replacing the trade credit with a bank loan that has a 10 percent annual cost. a. What is the amount of free trade credit that Langley obtains from Consolidated Services? (Assume 360 days per year throughout this problem.) b. What is the amount of costly trade credit? c. What is the approximate annual percentage cost of the costly trade credit? d. Should Langley replace its trade credit with the bank loan? Explain your answer. e. If the bank loan is used, how much of the trade credit should be replaced?
Explanation / Answer
Ans a) Assume 360 days per year throughout this problem.)
= 0.975 x $400,000/360
= $390,000/ 360 = $1,083.33
for 10 days = 10 x $1,083.33 = $10,833.33
The amount of free trade credit that Langley obtains from consolidated Services is $10,833.33.
ans b) 45 x $1,083.33 = $48,750
$48,750 – $10,833.33 = $37,916.67
The amount of costly trade credit is $37,916.67.
ans c) Annual cost of costly trade = 2.5%/(1 - 2.5%) * (360/(45 -10))
= (2.5/97.5)*(360/35)
=26%
ans d) Langley should replace its trade credit with a bank lean only if they can get a better cost than the 26% that they already have.
ans e) The costly trade credit should be replaced minus the $10,033.33 of free trade credit.
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