Question

Pets Store Inc. sells on terms of 2/20, net 55. What is the effective annual cost of trade credit under these terms? Use a 365-day year.

Please round two decimal places in percentage form.

Answer 1

Discount Rate = 2.00%
Discount Period = 20 days
Credit Period = 55 days

Effective Cost of Trade Credit = [1 + Discount Rate / (1 - Discount Rate)]^[365 / (Credit Period - Discount Period)] - 1
Effective Cost of Trade Credit = [1 + 0.02 / (1 - 0.02)]^[365 / (55 - 20)] - 1
Effective Cost of Trade Credit = [1 + 0.02 / 0.98]^[365 / 35] - 1
Effective Cost of Trade Credit = 1.020408^10.428571 - 1
Effective Cost of Trade Credit = 1.2345 - 1
Effective Cost of Trade Credit = 0.2345 or 23.45%