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    Terms of sale-effective annual interest rate

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    A firm offers terms of 1/10, net 30. What effective annual interest rate does the firm earn when a customer does not take the discount? Without doing any calculations, explain what will happen to this effective rate if:

    a. The discount is changed to 2 percent.

    b. The credit period is increased to 45 days.

    c. The discount period is increased to 20 days.

    d. What is the EAR for each scenario?

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    Solution Preview

    A firm offers terms of 1/10, net 30. What effective annual interest rate does the firm earn when a customer does not take the discount? Without doing any calculations, explain what will happen to this effective rate if:

    a. The discount is changed to 2 percent.

    b. The credit period is increased to 45 days.

    c. The discount period is increased to 20 days.

    d. What is the EAR for each scenario?

    A firm offers terms of 1/10, net 30. What effective annual interest rate does the firm earn when a customer does not take the discount?

    Terms
    Dicount= 1%
    Discount period= 10 days
    Period after which the account becomes overdue= 30 days

    Assume the payment is for $100.00
    During the first 10 days you obtain a free ride on the seller's credit
    If you do not take the cash discount, in effect you are borrowing the difference between the total amount billed
    $100.and the amount of the cash discount $1. which, of course is $99.

    Per period cost of loan
    = dollar cash discount/dollar amount of loan= $1./ $99. = 1.01%

    No of periods= 365 days/ (30days - 10days ...

    Solution Summary

    The solution calculates the effective annual interest rate that the firm earns when a customer does not take the discount.

    $2.19

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