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CMA Intermediate · Financial Management and Business Data Analytics · Payable Management

Sharma Textiles Ltd buys raw material on terms '2/10, net 40'. If it forgoes the cash discount and pays on the 40th day, what is the approximate annual implicit cost of the trade credit (using a 360-day year and the simple formula)?

The implicit cost is about 24.5% a year. Forgoing a 2% discount means paying 30 extra days for 98 of effective funds: (2/98) x (360/30) = 24.49%. Using the full-period gap or the discount on the wrong base gives lower, incorrect figures.

  1. A24.50%Correct
  2. B12.24%
  3. C18.37%
  4. D14.69%

Explanation

Cost = [Discount/(100 - Discount)] x [360/(Credit period - Discount period)] = (2/98) x (360/30) = 0.020408 x 12 = 24.49%, i.e. about 24.50%. The 12.24% option uses 180 days (wrongly dividing by 60). The 14.69% option uses 2/98 x 360/50, taking a 50-day gap.

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