Concept explainers
Terms of Sale [LO1] A firm offers terms of 1/10, net 30. What effective annual interest rate does the firm earn when a customer does not take the discount? Without doing any calculations, explain what will happen to this effective rate if:
a. The discount is changed to 2 percent.
b. The credit period is increased to 45 days.
c. The discount period is increased to 15 days.
(a)
To determine: The effective annual rate (EAR)
Introduction:
Credit term refers to customer’s ability to acquire goods before making payment, depends on the trust that payment will be paid in future.
Answer to Problem 5QP
The effective annual rate (EAR) is 20.13%.
Explanation of Solution
Given information:
The terms “1/10 net 30” means the customers receive 1% discount if they make the payment in 10 days, with the total amount due in 30 days if the discount is not received.
In this case, 30 days is the credit period, 10 days is the period of discount, and 2% is the amount of cash discount.
Here, the percentage of discount interest is 1% on
The formula to calculate the periods per year:
Hence, the periods per year is 18.25.
The formula to calculate the periodic interest rate:
Hence, the periodic interest rate is 1.01%.
The formula to calculate effective annual rate:
Hence, the effective interest rate is 20.13%.
To determine: The EAR.
Answer to Problem 5QP
The effective annual rate (EAR) is 44.59%.
Explanation of Solution
Given information:
The terms “2/10 net 30” means the customers receive 2% discount if they make the payment in 10 days, with the total amount due in 30 days if the discount is not received.
In this case, 30 days is the credit period, 10 days is the period of discount, and 2% is the amount of cash discount.
Here, the percentage of discount interest is 2% on
The formula to calculate the periods per year:
Hence, the periods per year is 18.25.
The formula to calculate the periodic interest rate:
Hence, the periodic interest rate is 2.04%.
The formula to calculate effective annual rate:
Hence, the effective interest rate is 44.59%.
(b)
To determine: The effective annual rate (EAR)
Answer to Problem 5QP
The effective annual rate (EAR) is 11.05%.
Explanation of Solution
Given information:
The terms “1/10 net 45” means the customers receive a 1% discount if they pay in 10 days, with the total amount due in 45 days if the discount is not received.
In this case, 45 days is the credit period, 10 days is the period of discount, and 1% is the amount of cash discount.
Here, the percentage of discount interest is 1% on
The formula to calculate the periods per year:
Hence, the periods per year is 10.43.
The formula to calculate the periodic interest rate:
Hence, the periodic interest rate is 1.01%.
The formula to calculate effective annual rate:
Hence, the effective interest rate is 11.05%.
(c)
To determine: The effective annual rate (EAR)
Answer to Problem 5QP
The effective annual rate (EAR) is 27.71%.
Explanation of Solution
Given information:
The terms “1/15 net 30” mean the customers receive a 1% discount if they pay in 10 days, with the total amount due in 30 days if the discount is not received.
In this case, 30 days is the credit period, 15 days is the period of discount, and 2% is the amount of cash discount.
Here, the percentage of discount interest is 1% on
The formula to calculate the periods per year:
Hence, the periods per year is 24.33.
The formula to calculate the periodic interest rate:
Hence, the periodic interest rate is 1.01%.
The formula to calculate effective annual rate:
Hence, the effective interest rate is 27.71%.
Want to see more full solutions like this?
Chapter 20 Solutions
Fundamentals of Corporate Finance, 2 Semester Access, FIN 3043
- Mf4. . Assume that you bought a Treasury bill at price=92.450 and sold two days later at 92.550. What is your holding period return? What is your annualized return?arrow_forward1.A firm is offered trade credit terms of 3/15, net 30 days. The firm does not take the discount, and it pays after 50 days. Questions: - What is the annual nominal rate of not taking this discount? - How much is the rate per period?arrow_forwardA firm offers terms of 2/20, net 50. What effective annual interest rate does the firm earn if the credit period is increased to 70 days? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)d.What effective annual interest rate does the firm earn if the discount period is increased to 25 days? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)arrow_forward
- f a firm buys under terms of 3/15, net 50, but actually pays on the 20th day and still takes the discount, what is the nominal cost of its nonfree trade credit? Assume a 365-day year. Do not round intermediate calculations. Round your answer to two decimal places. % Does it receive more or less credit than it would if it paid within 15 days? I. Paying after the discount period, but still taking the discount gives the firm less credit than it would receive if it paid within 15 days. II. Paying before the discount period and taking the discount gives the firm more credit than it would receive if it paid within 15 days. III. Paying after the discount period, but still taking the discount gives the firm more credit than it would receive if it paid within 15 days.arrow_forwardQUESTION 3 A 180-day $500,000 banker's acceptance (BA) is currently trading at a discount of 3.75%. You purchase the BA today and sell it 90 days later when the three-month yield is 4.10%. What is your rate of return? Use 360-day to annualize. The following is true, except The price of the BA today is $490,625 The price of the BA 90 days from today is $494,875 Your rate of return is -3.46% Your rate of return is 3.46% QUESTION 4 The following Is true for standby letters of credit (SBLCs), except: The bank receives an annual fee for using a SBLC for the life of the bond issue The fee for SLBCs for municipal bonds depends on…arrow_forwardQ. Emmar Industries borrows $800 million at an interest rate of 7.6%. Emmar will pay tax at an effective rate of 35%. What is the present value of interest tax shields if?(a.) It expects to maintain this debt level into the far future?(b.) It expects to repay the debt at the end of 5 years?(c.) It expects to maintain a constant debt ratio once it borrows the $800 million and rassets =10%?arrow_forward
- Q: Which Is the better option to consolidate debt? Option 1: You have a loan at $21,000 at 16.24% (APR) 3 year term, Making the minimum payment monthly. Option 2: You have two loans; 1: $10, 700 at 8.99% (APR), 3 year term, Making the minimum payment monlthy. 2: $ 10,300 at 12.24% (APR), 3 year Term, Making the minimum payment monthly. Which option saves the most in interest, which is the better option to save the most money?arrow_forwardRequired: a. A firm currently offers terms of sale of 3/25, net 50. Calculate the effective annual rate. a-1. Calculate the effective annual rate if the terms are changed to 4/25, net 50. a-2. What effect does an increase in the discount rate have on the implicit interest rate charged to customers that pass up the discount? b-1. Calculate the effective annual rate if the terms are changed to 3/35, net 50. b-2. What effect does a decrease in the extra days of credit have on the implicit interest rate charged to customers that pass up the discount? c-1. Calculate the effective annual rate if the terms are changed to 3/25, net 40. c-2. Is there any difference between the implicit interest rate for terms of 3/35, net 50 and 3/25, net 40?arrow_forwardMf4. You've worked out a line of credit arrangement that allows you to borrow up to $80million at any time. The interest rate is0.61 percent per month. In addition, 4 percent of the amount that you borrow must be deposited in a non-interest-bearing account. Assume that your bank uses compound interest on its line of credit loans. Required: (a)What is the effective annual interest rate on this lending arrangement? (Do not round your intermediate calculations.) (b)Suppose you need $16 million today and you repay it in 6 months. How much interest will you pay? (Do not round your intermediate calculations.)arrow_forward
- The spot rate: USD 1.21/EUR 2-year USD YTM=0.11% 2-year EUR YTM= -0.72%. Suppose that you invest in the strategy known as the "carry trade". What will be your profit/loss if the spot rate in 2 years is USD 1.00/EUR. PROFIT = $1,100 or THERE IS NO ARBITRAGE OPPORTUNITY IS AN INCORRECT ANSWERarrow_forwardQuantitative Problem: Adams Manufacturing Inc. buys $9.1 million of materials (net of discounts) on terms of 2/10, net 50; and it currently pays after 10 days and takes the discounts. Adams plans to expand, which will require additional financing. If Adams decides to forgo discounts, how much additional credit could it obtain? Assume 365 days in year for your calculations. Do not round intermediate calculations. Round your answer to the nearest cent.$ What would be the nominal and effective cost of such a credit? Assume 365 days in year for your calculations. Do not round intermediate calculations. Round your answer to two decimal places.Nominal cost: %Effective cost: % If the company could receive the funds from a bank at a rate of 9%, interest paid monthly, based on a 365-day year, what would be the effective cost of the bank loan? Do not round intermediate calculations. Round your answer to two decimal places. % Should Adams use bank debt or additional trade credit?arrow_forwardP14–10 Relaxation of credit standards Lewis Enterprises is considering relaxing its credit standards to increase its currently sagging sales. As a result of the proposed relaxation, sales are expected to increase by 10% from 10,000 to 11,000 units during the coming year, the average collection period is expected to increase from 45 to 60 days, and bad debts are expected to increase from 1% to 3% of sales. The sale price per unit is $40, and the variable cost per unit is $31. The firm’s required return on equal-risk investments is 10%. Evaluate the proposed relaxation, and make a recommendation to the firm. (Note: Assume a 365-day year.)arrow_forward