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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

COST OF TRADE CREDIT AND BANK LOAN Lamar Lumber buys $8 million of materials (net of discounts) on terms of 3/5, net 60; and it currently pays on the 5th day and takes discounts. Lamar plans to expand, which will require additional financing. If Lamar decides to forgo discounts, how much additional credit could it obtain, and what would be the nominal and effective cost of that credit? If the company could get the funds from a bank at a rate of 10%, interest paid monthly, based on a 365-day year, what would be the effective cost of the bank loan? Should Lamar use bank debt or additional trade credit? Explain.

Summary Introduction

To determine: The effective cost of the bank loan and the additional trade credit.

Trade credit:

Trade credit can be defined as an agreement by which a customer buys goods on account and paying the supplier at a particular date.

Explanation

Calculate the value of additional credit.

Additionalcredit=$8,000,000365×55=$1,205,479.45

Therefore, the additional credit is $1,205,479.45.

Calculate the nominal rate of trade credit.

Nominal rate of trade credit=397×36555=3.09%×6.6364=20.52%

Therefore, the nominal rate of trade credit is 20.52%.

Calculate the effective cost of the bank loan.

Effectivecostofbankloan=(1+Nominalrate)

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