Mr. Hugh Warner is a very cautious businessman. His supplier offers trade credit
ID: 2643302 • Letter: M
Question
Mr. Hugh Warner is a very cautious businessman. His supplier offers trade credit terms of 2/13, net 50. Mr. Warner never takes the discount offered, but he pays his suppliers in 40 days rather than the 50 days allowed so he is sure the payments are never late.
What is Mr. Warner's cost of not taking the cash discount? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
What is Mr. Warner's cost of not taking the cash discount? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Explanation / Answer
Credit terms of 2/13, net 50 represents that if the payments are made within 13 days then a discount of 2% will be allowed to the buyer, if the payment is beyond 13th Day but earlier than 50th day then no discounts are allowed, also 50th day is last day on which payment should be made so that there is no delay or overdue.
Under the present instance, Mr. Hugh Warner who doesnot exercises the option of discount may set to lose on certain earnings he could have made. For example if the purchase amount is let say $ 100 the if the payment ismade by the 13th Day then he would have to pay $ 2 less, that is, $ 98. Now, consequently if he deposits this amount in various money market instruments availble he could have earned some interest on this $ 2. Suppose, a bond or a CD providing 8% coupon payments or 8 % interest per annum then at the end of the year he would have earned $ 0.16.
Therefore, since he pays on the 40th day, interest plus discount could have been earned for 27 days. Hence, $ 0.012 (27 * 0.16 / 360) plus $ 2 are lost. Thus the cost of not taking the cash discount will be 2.01% in 27 day period (2.012 / 100).
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