If a firm buys on trade credit terms of 3/10, net 50 and decides to forgo the trade credit discount and pay on the net day, what is annualized cost of forgoing the discount (assume a 360-day year)?
The annualized cost of the trade credit terms of 3/10, net 50 is ___%
0.03/1-0.03*360/(50-10)
=10.08/0.97*40
=10.08/38.8
=0.27835 ie 27.385%
To calculate the annualized cost of forgoing the trade credit discount, you need to consider the discount period and the cost of not taking the discount.
1. Calculate the discount period:
The discount period in trade credit terms 3/10 means that the firm can take a 3% discount if payment is made within 10 days. So, the discount period is 10 days.
2. Calculate the cost of not taking the discount:
The cost of not taking the discount is the interest cost for the remaining payment period, which is 50 days in this case. To calculate this cost, you need to determine the effective annual interest rate.
The formula to calculate the effective annual interest rate (EAR) is:
EAR = (1 + (Discount % / (1 - Discount %)))^(365 / Number of Days) - 1
In this case, the discount percentage is 3% and the number of days is 50.
Using the formula, we can calculate the EAR for forgoing the discount:
EAR = (1 + (0.03 / (1 - 0.03)))^(365 / 50) - 1
Calculating this equation gives us the effective annual interest rate for forgoing the discount.
3. Calculate the annualized cost:
The annualized cost is the effective annual interest rate multiplied by the number of payment periods in a year. In this case, the year is assumed to have 360 days.
Annualized Cost = EAR * (360 / Number of Days)
Plugging in the values, you can calculate the annualized cost of forgoing the discount.
Please note that the calculations are for illustrative purposes only and the actual cost may vary based on specific factors.