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IAI Actuarial Core Principles · Business Finance · Financial instruments issued or used by companies

Sundaram Traders is offered terms of 2/10, net 30 by its supplier. Using the simple approximation (discount %/(100 - discount %) x 365/(days of credit forgone)), what is the approximate annual cost of forgoing the discount and paying on day 30?

The approximate annual cost is about 37.2%. Forgoing the discount gains 20 extra days of credit (30 minus 10) at a cost of 2/98, which is 2.04%, and 365 divided by 20 gives 18.25 periods a year, so 2.04% times 18.25 is about 37.2%.

  1. AAbout 2.0%
  2. BAbout 14.9%
  3. CAbout 18.6%Correct
  4. DAbout 37.2%
  5. About 24.0%

Explanation

Credit period gained by not taking the discount is 30 - 10 = 20 days. Simple cost = 2/98 x 365/20 = 0.020408 x 18.25 = 37.2%. Check: 365/20 = 18.25; 18.25 x 2.0408% = 37.24%. So the correct figure is 37.2%; the 18.6% option halves it by using 40 days wrongly.

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