A supplier offers your firm a 2% discount if you pay your bill within 10 days of the invoice. Otherwise, the full balance is due in 40 days. What is the effective annual cost of forgoing the
Discount and using this trade credit? Assume a 365-day year, and round your answer to the
Nearest tenth of a percent.

Question

Quizplus · Accepted Answer

To find the effective annual cost of forgoing the discount, we need to find the cost of using the trade credit and compare it to the cost of paying within 10 days.

If we take the discount, we pay 98% of the invoice amount and pay within 10 days. If we forgo the discount, we pay the full invoice amount and pay within 40 days.

Using the formula: Effective Annual Cost = (Discount %/(100% - Discount %)) x (365/(Final Payment Date - Invoice Date))

Taking the discount: Effective Annual Cost = (2%/98%) x (365/10) = 7.34%
Forgoing the discount: Effective Annual Cost = 0% x (365/40) = 0%

Therefore, taking the discount has an effective annual cost of 7.34%, while forgoing the discount has an effective annual cost of 0%. The best choice is to take the discount and pay within 10 days, as it has a lower effective cost.

A Supplier Offers Your Firm a 2% Discount If You