A firm offers terms of 2.6/7, net 30. What effective annual interest rate does t

Question

A firm offers terms of 2.6/7, net 30. What effective annual interest rate does the firm earn when a customer does not take the discount? What effective annual interest rate does the firm earn if the terms are changed to 3.6/7, net 30, and the customer does not take the discount? What effective annual interest rate does the firm earn if the terms are changed to 2.6/7, net 45, and the customer does not take the discount? What effective annual interest rate does the firm earn if the terms are changed to 2.6/12, net 30, and the customer does not take the discount?

Explanation / Answer

The effective interest rate is given by Discount % /(100- Discount percentage) * 365/Discount days

a. 2.6/7, net 30 : EAR when the firm does not take discount:

2.6/(100-2.6) * 365/(30-7) = 2.6/97.4 * 365/ 23 = 0.4236 = 42.36%

b. 3.6/7, net 30 : EAR when the firm does not take discount:

3.6/(100-3.6) * 365/(30-7) = 3.6/96.4 * 365/ 23 = 0.5926 = 59.26%

c. 2.6/7, net 45 : EAR when the firm does not take discount:

2.6/(100-2.6) * 365/(45-7) = 2.6/97.4 * 365/ 38 = 0.2564 = 25.64%

d.2.6/12, net 30 : EAR when the firm does not take discount:

2.6/(100-2.6) * 365/(30-12) = 2.6/97.4 * 365/ 38 = 0.5413 = 54.13%

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