Question

Inc. can buy its inventory from any of four suppliers all of which offer 4. Rocky Inc. can buy its inventory essentially the same pricing and quality. Their credit terms, however, vary considerably as follows: A 2/10, net 30 B 3/5, net 20 C 1/20, net 45 D 3/5, net 90 A). Calculate the implied interest rate associated with each policy. Assume a 365-day year. B). If Rocky buys some material from each vendor, which discounts should it take and which should it forego if it pays 18% for working capital financing? Why?

Answer 1

PART A

Cost of credit = (Discount%/(1-discount %)) * (365/(Days credit – discount period))

A: Cost of credit= (2%/(1-2%))*(365/(30-10))

=37.24%

B: Cost of credit= (3%/(1-3%))*(365/(20-5))

= 75.26%

C: Cost of credit= (1%/(1-1%))*(365/(45-20))

=14.75%

D: Cost of credit= (3%/(1-3%))*(365/(90-5))

=13.28%

PART B:

Select options C and D since the cost of credit is less than the cost of working capital.