Question

A large retailer obtains merchandise under the credit terms of 3/20, net 30, but routinely takes 65 days to pay its bills. (Because the retailer is an important customer, suppliers allow the firm to stretch its credit terms.) What is the retailer's effective cost of trade credit? Assume a 365-day year. Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

To calculate the retailer's effective cost of trade credit, we need to consider the discount and the number of days the retailer takes to pay its bills.

The credit terms of 3/20, net 30 mean that the retailer can take a 3% discount if the payment is made within 20 days; otherwise, the full amount is due within 30 days.

Given that the retailer routinely takes 65 days to pay its bills, it exceeds both the discount period and the net period. Therefore, it does not qualify for the discount.

The effective cost of trade credit can be calculated using the formula:

Effective Cost of Trade Credit = (Discount % / (1 - Discount %)) x (365 / (Number of Credit Days - Discount Days))

In this case, the discount is 3%, the number of credit days is 65, and the discount days is 20.

Effective Cost of Trade Credit = (0.03 / (1 - 0.03)) x (365 / (65 - 20))

Calculating the values:

Effective Cost of Trade Credit = (0.03 / 0.97) x (365 / 45)

Effective Cost of Trade Credit = 0.0309 x 8.1111

Effective Cost of Trade Credit ≈ 0.2507

Rounded to two decimal places, the retailer's effective cost of trade credit is approximately 0.25 or 25%.