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 forgo 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) can be calculated using the formula for the cost of not taking the discount: EAR = [(1 + (Discount % / (1 - Discount %)))^(365 / (Full allowed payment days - Discount days))] - 1. Plugging in the values: EAR = [(1 + (0.01 / (1 - 0.01)))^(365 / (40 - 10))] - 1 = 13.01%.