Lamar Lumber buys $8 million of materials (net of discounts) on terms of 3/5, ne

Question

Lamar Lumber buys $8 million of materials (net of discounts) on terms of 3/5, net 35; and it currently pays after 5 days and takes discounts. Lamar plans to expand, which will require additional financing. Assume 365 days in year for your calculations.

a.If Lamar decides to forgo discounts, how much additional credit could it obtain? Round your answer to the nearest cent.
$

b.What would be the nominal cost of that credit? Round your answer to two decimal places.
%


c.What would be the effective cost of that credit? Round your answer to two decimal places.
%


d.If the company could get the funds from a bank at a rate of 12%, interest paid monthly, based on a 365-day year, what would be the effective cost of the bank loan? Round your answer to two decimal places.
%

Explanation / Answer

= $8,000,000/365x 55 days = $1,205,479.45

Nominal cost of trade credit = 3/97 x 365/55 = 3.09% x 6.6364 = 20.52%

Effective cost of trade credit = (1 + 3/97)365/55 – 1 = 1.2240 – 1 = 22.40%.

Bank loan: 10%, interest paid monthly

EAR = (1 +0.10/12)12 – 1 = 1.1047 – 1 = 10.47%.

The effective cost of the bank loan is more than half the effective cost of the trade credit.

Therefore, the bank loan should be used

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