The Reynolds Corporation buys from its suppliers on terms of 3/13, net 45. Reyno

Question

The Reynolds Corporation buys from its suppliers on terms of 3/13, net 45. Reynolds has not been utilizing the discounts offered and has been taking 45 days to pay its bills. Mr. Duke, Reynolds Corporation vice president, has suggested that the company begin to take the discounts offered. Duke proposes that the company borrow from its bank at a stated rate of 17 percent. The bank requires a 26 percent compensating balance on these loans. Current account balances would not be available to meet any of this compensating balance requirement.

A) Calculate the cost of not taking a cash discount. (Use a 360-day year)

B) Calculate the effective rate of interest if the company borrows from the bank.

Explanation / Answer

A)

cost of not taking a cash discount = (1+3/(100-3))^(360/(45-13)) -1

cost of not taking a cash discount = 40.87%

B)

Effective rate of interest if the company borrows from the bank = (17/(100-26))

Effective rate of interest if the company borrows from the bank = 22.97%

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