CMA Intermediate · Financial Management and Business Data Analytics · Payable Management
Sharma Textiles Ltd buys fabric on terms '2/10, net 30'. If it skips the discount and pays on day 30, what is the approximate annual effective cost of this trade credit using the simple (non-compounded) formula on a 360-day year?
The simple annual cost is about 36.73%. Forgoing a 2% discount buys only 20 extra days of credit, so cost is 2/98 multiplied by 360/20. Since this exceeds typical bank borrowing rates, the firm should normally take the discount.
- A36.73%Correct
- B24.49%
- C18.37%
- D37.24%
Explanation
Cost = [2/(100-2)] x [360/(30-10)] = 0.020408 x 18 = 36.73%. The 24.49% option uses a 30-day credit period instead of the 20 days gained by forgoing the discount. The 18.37% option halves the result by wrongly using 40 days. The 37.24% option is the compounded figure, not the simple one asked for.
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