Your firm factors its accounts receivable immediately at a 3% discount. The average collection period is 41.95 days. Assume that all accounts are collected in full. What is the effective annual interest rate on this arrangement?

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Quizplus · Accepted Answer

The effective annual interest rate (EAR) can be calculated using the formula: EAR = (1 + i/n)^n - 1, where i is the interest rate per period and n is the number of periods per year. In this case, the interest rate per period is 3% (or 0.03 as a decimal), and the period is 41.95 days. To find the number of periods per year, divide 365 days by 41.95 days, which gives approximately 8.7 periods per year. Plugging these values into the EAR formula gives EAR = (1 + 0.03/8.7)^(8.7) - 1, which approximately equals 30.3%.

Your Firm Factors Its Accounts Receivable Immediately at a 3