Reese Company purchased merchandise with an invoice price of $2,000 and credit terms of 2/10, n/30. Assuming a 360 day year, what is the implied annual interest rate inherent in the credit terms?
A) 20%
B) 24%
C) 36%
D) 72%

Question

Quizplus · Accepted Answer

The credit terms 2/10, n/30 mean that the buyer can take a 2% discount if they pay within 10 days, or pay the full amount within 30 days. If the buyer takes the discount, they would pay $2,000 * 0.98 = $1,960. The discount is $2,000 - $1,960 = $40.

To find the annual interest rate inherent in the credit terms, we can calculate the effective annual rate (EAR) using the following formula:

EAR = (1 + periodic rate)^m - 1

where periodic rate = discount % ÷ (100% - discount %) and m = 360 ÷ (payment period - discount period)

In this case, the payment period is 30 days and the discount period is 10 days, so m = 360 ÷ (30 - 10) = 18.

The periodic rate = 2% ÷ (100% - 2%) = 2.04%. Plugging these values into the formula, we get:

EAR = (1 + 0.0204)^18 - 1 = 0.3737 or 37.37%

Therefore, the implied annual interest rate is 37.37%, which is closest to choice C.

Reese Company Purchased Merchandise with an Invoice Price of $2,000