1. (Effective annual rate) Compute the cost of the following trade credit terms
ID: 2765099 • Letter: 1
Question
1. (Effective annual rate) Compute the cost of the following trade credit terms using the compounding formula, or effective annual rate. Note: assume a 30 day month and 360 day year.
A 3/5, net 45
B 4/10, net 30
C 3/10, net 75
D 2/15, net 60
A When payment is made on the net due date, the APR of the credit terms of 3/5, net 45 is __%, (round to two decimal places).
The EAR of the credit terms of 3/5, net 45 is __%, (round to two decimal places).
B When payment is made on the net due date, the APR of the credit terms of 4/10, net 30 is __%, (round to two decimal places).
The EAR of the credit terms of 4/10, net 30 is __%, (round to two decimal places).
C When payment is made on the net due date, the APR of the credit terms of 3/10, net 75 is __%, (round to two decimal places)
The EAR of credit terms of 3/10, net 75 is __%, (round to two decimal places)
D When payment is made on the net due date, the APR of the credit terms of 2/15, net 60 is __%, (round to two decimal places)
The EAR of the credit terms of 2/15, net 60 is __%, (round to two decimal places)
Explanation / Answer
Nominal cost of trade credit = [ Discount percentage / (100- Discount Percentage) ] x [ 360Days / (credit is Outstanding-Discount Period) ] A Term 3/5, n45 APR =3/97*360/(45-5) 27.84% APR is 27.84% EAR = (1+r/n)^n-1 r= APR n=no of compounding periods here n =360/(45-5)=9 EAR =(1+0.2784/9)^9-1 31.55% So EAR is 31.55% B Term 4/10, net 30 APR =4/96*360/(30-10) 75.00% APR =75% EAR = (1+r/n)^n-1 r= APR n=no of compounding periods here n =360/(30-10)=18 EAR =(1+0.75/18)^18-1 108.51% EAR =108.51% C Term 3/10, net 75 APR =3/97*360/(75-10) 17.13% APR =17.13% EAR = (1+r/n)^n-1 r= APR n=no of compounding periods here n =360/(75-10)=5.54 EAR =(1+0.0.1713/5.54)^5.54-1 18.38% EAR =18.38% D Term 2/15, n60 APR =2/85*360/(60-15) 18.82% APR =18.82% EAR = (1+r/n)^n-1 r= APR n=no of compounding periods here n =360/(60-15)=8 EAR =(1+0.0.1828/8)^8-1 19.81% EAR =19.81%
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