The D.J. Masson Corporation needs to raise $600,000 for 1 year to supply working

Question

The D.J. Masson Corporation needs to raise $600,000 for 1 year to supply working capital to a new store. Masson buys from its suppliers on terms of 1/10, net 90, and it currently pays on the 10th day and takes discounts. However, it could forgo discounts, pay on the 90th day, and get the needed $600,000 in the form of costly trade credit. What is the effective annual interest rate of this trade credit? Assume 365 days in year for your calculations. Do not round intermediate calculations. Round your answer to two decimal places.

%

Explanation / Answer

Trade credit =1/99 [i.e you will have to pay 99 if 1 % discount is allowed]. , and paid within 10 days

otherwise pay in 90 days , so 90-10 = 80 days additional credit period is allowed.at a cost of 1/99

Number of periods = 365/80 = 4.5625 (approx 5)

so effective annual interest rate =(1+1/99)^5 -1

                                              =(1+.0101)^5 -1

                                             = (1.0101)^5 -1

                                                = 5.15%

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