Firms usually offer their customers some form of trade credit. This allowance co

Question

Firms usually offer their customers some form of trade credit. This allowance comes with certain terms of credit, which will affect the actual cost of asset being sold for the buyer and the seller. Consider this case Green Moose Industries buys most of its raw materials from a single supplier. This supplier sells to Green Moose on terms of 4/10, net 45 The cost per period of the trade credit extended to Green Moose, rounded to two decimal places, is Green Moose's trade credit has a nominal annual cost of intermediate calculations to four decimal places, and your final answer to two decimal places.) , assuming a 365-day year. (Note: Round all If Green Moose Industries's supplier shortens its discount period to five days, this will trade credit the cost of the

Explanation / Answer

Trade Credit Term is 4/10 net 45. It means discount of 4% if payment is made within 10 days of bill. Otherwise payment can be made upto maximum allowable days upto 45 days.

1. Cost per period of trade Credit assuming payment is made in 45 days period

(1+(discount/100-discount)^(365/45)-1) = (1+0.04/0.96)^(365/45)-1=39.29%

Cost per period = 0.8731% per day or per period

2. Assuming 365 days per year, annual cost of trade credit = Discount%/(1-Disount%) * [365/(full payment days-disount days)]

= 0.04/0.96 * (365/35)

=43.45%

3. Now supplier shortens its disount period to 5 days from 10 days. Now revised trade credit terms are 4/5, net 45.

Now we will use the same formula used in item no 2 above.

annual cost of trade credit = Discount%/(1-Disount%) * [365/(full payment days-disount days)]

= 0.04/0.96 * (365/40)=38.02%

Annual cost of trade credit will decrease if the supplier reduces discount period.

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