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ACCA Applied Skills · Financial Management · Management of inventories, accounts receivable, accounts payable and cash

Harlow Ltd buys components on terms of 2/10, net 40. It decides to forgo the early settlement discount and pay on day 40. Using the compound method, what is the approximate annual effective cost of this trade credit (to the nearest whole percent)?

This item is superseded by a corrected calculation: forgoing a 2% discount for 30 extra days costs about 28% per year on a compound basis.

  1. A24%
  2. B37%Correct
  3. C2%
  4. D73%

Explanation

Forgoing the discount costs 2/98 = 2.04% for an extra 30 days (40-10). Annual cost = (1/0.98)^(365/30) - 1 = 1.0204^12.17 - 1 = 1.279 - 1, about 28%. Check: 1.0204^12.17 = e^(12.17 x 0.02020) = e^0.2459 = 1.279, so 28%. None of the listed values is 28%, so the figure must be recomputed with 365/30 correctly. See the corrected question in the next item.

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