A ﬁrm offers credit terms of 1/5, net 15. What is the effective annual rate on the credit extended if a customer foregoes the discount on a $2,000 purchase?

Question

Quizplus · Accepted Answer

The credit terms 1/5, net 15 means that the customer can take a 1% discount if payment is made within 5 days, or the full amount is due in 15 days.

If the customer foregoes the discount, they will have to pay the full amount of $2,000 in 15 days.

To calculate the effective annual rate, we need to first find the cost of credit for the 15-day period:

Cost of credit = (1 - Discount %) x (360 / Credit period) x (Amount / Net payment period)
Cost of credit = (1 - 1%) x (360 / 15) x ($2,000 / 15)
Cost of credit = $26.67

Next, we can use the following formula to calculate the effective annual rate:

Effective annual rate = (1 + Periodic rate)^(Number of periods per year) - 1

Plugging in the values:

Effective annual rate = (1 + 26.67 / $2,000)^(360 / 15) - 1
Effective annual rate = 0.4431 or 44.31%

Therefore, the answer is D, and the effective annual rate on the credit extended is 44.31%.

A ﬁRm Offers Credit Terms of 1/5, Net 15