What is the effective annual cost of credit terms of 1/10 net 30, if the firm stretches the accounts payable to 45 days?

Question

Quizplus · Accepted Answer

To find the effective annual cost of credit terms, we need to find the annual percentage rate (APR).

Here's the calculation:

Discounted price = Full price - Discount 
Discounted price = Full price - (Full price x Discount rate)

Since the terms are 1/10 net 30, the discount rate is 1%.

Discounted price = Full price - (Full price x 0.01)

The firm stretches the accounts payable to 45 days, which is equal to 1.5 months.

APR = (Discounted price/Full price) x (360 days/1.5 months)

Now we can substitute the Discounted price formula from above:

APR = [(Full price - (Full price x 0.01))/Full price] x (360/1.5)

APR = (1 - 0.01) x (360/1.5) = 24.48%

Since the firm is stretching the accounts payable to 45 days, the effective annual cost of credit terms is higher than the APR.

Effective annual cost = [(1 + (Discount rate/(1-Discount rate)))^365/Number of days payable -1] x 100%

Effective annual cost = [(1 + (0.01/(1-0.01)))^365/45 - 1] x 100% = 11.05%

Therefore, the best choice is C, 11.05%.

What Is the Effective Annual Cost of Credit Terms of 1/10