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

Question

Holiday 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. Holiday plans to expand, which will require additional financing. Assume 365 days in year for your calculations.

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

$____________

2. What would be the nominal cost of that credit?

37.62%

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

_____________%

4. 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?

12.68%

Explanation / Answer

Purchases = $8,000,000; terms = 3/5net 60; currently pays on Day 5 and takes discounts.
Forgoesdiscounts; additional credit = X
$8,000,000/365*55 days = $1,205,479.45.
Nominal cost oftrade credit =3 x 365 = 3.09% * 6.6364 = 20.52%.
97 55
Effective costof 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 effectivecost of the bank loan is more than half the effective cost of thetrade credit. Therefore , the bank loan should be used.

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