You are offered the following terms: 5/25 net 50.What is the effective annual interest rate for not paying on time, approximately?
A)111.5%
B)103.9%
C)76.8%
D)45.4%

Question

Quizplus · Accepted Answer

The terms 5/25 net 50 mean that a 5% discount is offered if payment is made within 25 days; otherwise, the full amount is due in 50 days. If not taking the discount, effectively, a 5% cost is incurred for extending the payment from 25 to 50 days, which is 25 days. To find the effective annual interest rate, we calculate the interest rate for the period and then annualize it. The formula for the effective annual interest rate (EAR) is EAR = (1 + i/n)^n - 1, where i is the interest rate for the period, and n is the number of periods in a year. In this case, i = 5% for 25 days, so for a 365-day year, n = 365/25. The EAR significantly exceeds 100%, making option A (111.5%) the closest approximation.

You Are Offered the Following Terms: 5/25 Net 50