Firms usually offer their customers some form of trade credit. This allowance comes with certain terms of credit

Firms usually offer their customers some form of trade credit. This allowance comes with certain terms of credit

 

answer:

True price of the invoice = (100%-discount rate)*invoice amount

= (100%-3.5%)*1254.98

= $1,211.06. This means that there will be a 3.5% penalty if not paid within 10 days.

The cost of trade credit extended by the supplier can be computed using the formula: discount%/(1-discount %)*(360/full allowed payment days-discount days)

= 3.5%/1-3.5%*(360/45-10)

= 3.6269%*10.2857

= 37.31%.

If Free Spirit does not take the advantage of the discount then it will effectively pay 3.5% of interest for 45-10 = 35 days use of credit. Thus the cost will be = 360/35*3.5%

= 36%

The decrease in nominal cost of trade credit = 37.31%-36% = 1.31%

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