The Masson Corporation needs to raise $500,000 for one year to supply working ca
ID: 2781962 • Letter: T
Question
The Masson Corporation needs to raise $500,000 for one year to supply working capital to a new store. Masson buys from its suppliers on terms of 3/10, net 90, and it currently pays on the 10th day and takes discounts, but it could forgo discounts, pay on the 90th day, and get the needed $500,000 in the form of costly trade credit. Alternative, Masson could borrow from its bank on a 12% discount interest rate basis.
a. What is the effective annual interest rate of forgoing discounts?
b. What is the effective annual interest of the bank loan?
Explanation / Answer
a:
2/10 net 90: pay in 10 days and take 2% discount otherwise pay in 90 days
EAR = (2/98)*(360/80) = 0.0918 = 9.18%
b:
m = 360/90 = 4
d = 12/4 = 3%
d = i/(1 + i), i = d/(1 – d) = 3%/0.97
EAR = (1 + 0.03/0.97)^(360/90) – 1 = 0.12957 = 12.96%
Bank discount yield is based on 360 days but effective annual yield is based on 365 days.
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