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Trade credit - implicit interest rate

Trade Credit Rates - A firm currently offers terms of sale of 3/20, net 40. What effect will the following actions have on the implicit interest rate charged to customers that pass up the cash discount? State whether the implicit interest rate will increase or decrease.

a) the terms are changed to 4/20, net 40
b) the terms are changed to 3/30, net 40
c) the terms are changed to 3/20, net 30

Solution Preview

See the attached file where the complete answer is given

Effective annual cost of foregoing cash discounts =
= [(1 + per period rate)^number of periods per year - 1] X 100

terms of sale of 3/20, net 40
Terms
Dicount= 3%
Discount period= 20 days
Period after which the account becomes overdue= 40 days

Assume the payment is for $100.00
During the first 20 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 3. which, of course is 97.

Per period cost of loan
= dollar cash discount/dollar amount of loan= 3./ 97. = 3.09%

No of periods= 365 days/ (40days - 20days )= 18.25 periods

Effective annual cost of foregoing cash discounts =
= [(1 + ...

Solution Summary

The solution calculates the implicit interest rate charged to customers that pass up the cash discount for different credit terms.

$2.19