A firm offers terms of 1/10, net 25. (Enter your answers as directed, but do not

Question

A firm offers terms of 1/10, net 25. (Enter your answers as directed, but do not round intermediate calculations.)

Requirement 1: What effective annual interest rate does the firm earn when a customer does not take the discount? (Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Effective annual interest rate %=

Requirement 2: What effective annual interest rate does the firm earn if the discount is changed to 2 percent? (Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Effective annual interest rate % =

Requirement 3: What effective annual interest rate does the firm earn if the credit period is increased to 45 days? (Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Effective annual interest rate %=

Requirement 4: What effective annual interest rate does the firm earn if the discount period is increased to 15 days? (Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Effective annual interest rate %=

Explanation / Answer

Req 1. Nominal cost of trade credit = [ Discount percentage / (100- Discount Percentage) ] x [ 365Days / (credit is Outstanding-Discount Period) Term1/10, n25 Nominal Cost = 1/99*365/(25-10) = 24.57912% Nominal Cost of credit = 24.5791% EAR = (1 + periodic rate)^N – 1 =(1+r/n)^n-1 N=no of compounding done Periods per year=365/(25-10) =24.33 Peridic rate =24.5791/24.33=1.010% EAR = (1.01010^24.33-1)                = 27.70% So efferctive interest rate of credit = 27.70% So effective interest earned is 27.7% Term2/10, n25 Nominal Cost = 2/99*365/(25-10) = 49.158% Nominal Cost of credit = 49.158% EAR = (1 + periodic rate)^N – 1 =(1+r/n)^n-1 Periods per year=365/(25-10) =24.33 Peridic rate =49.158/24.33=2.0205% EAR = (1.020205^24.33-1)            = 62.69% So efferctive interest rate of credit =62.69% So effective interest earned is 62.69% Req 3 Term1/10, n45 Nominal Cost = 1/99*365/(45-10) = 10.534% Nominal Cost of credit = 10.534 EAR = (1 + periodic rate)^N – 1 =(1+r/n)^n-1 Periods per year=365/(45-10) =10.43 Peridic rate =10.534/10.43=1.01010% EAR = (1.01010^10.43-1)            = 11.05% So efferctive interest rate of credit =11.05% So effective interest earned is 11.05% Req 4 Term1/15, n25 Nominal Cost = 1/99*365/(25-15) = 36.869% Nominal Cost of credit =36.869% EAR = (1 + periodic rate)^N – 1 =(1+r/n)^n-1 Periods per year=365/(25-15) =36.50 Peridic rate =36.869/36.5=1.1010% EAR = (1.01010^36.5-1)            = 44.31% So efferctive interest rate of credit =44.31% So effective interest earned is 44.31%

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