Hefner Inc.'s business is booming,and it needs to raise more capital.The company purchases supplies on terms of 1/10,net 20,and it currently takes the discount.One way of getting the needed funds would be to forego the discount,and the firm's owner believes she could delay payment to 40 days without adverse effects.What would be the effective annual rate of funds raised by this action? (Assume a 365-day year.)

Question

Quizplus · Accepted Answer

The effective annual rate (EAR) of funds raised by foregoing the discount can be calculated using the formula for the cost of not taking a trade discount: EAR = [1 + (Discount / (1 - Discount))]^(365 / (Payable Days - Discount Days)) - 1. Here, the discount is 1% (1/10), and by not taking the discount and paying in 40 days instead of 10, the company effectively borrows the funds for 30 days (40-10). Plugging the numbers into the formula gives: EAR = [1 + (0.01 / (1 - 0.01))]^(365/30) - 1, which approximates to 13.01%.