Your firm purchases goods from its suppier on terms of 1/22, net 42. What is the effective annual cost to yourfirm if it chooses not to take advantage of the trade discount offered

The effective annual cost to yourfirm if it chooses not to take advantage of the trade discount offered is:

= 18.25%.

Explanation:

a) Data and Calculations:

Terms 1/22, net 42: This effectively provides a discount of 1% if the firm pays its supplier within 22 days from the date of purchase.  After the 22 days up to 42 days, the firm pays the full amount.  This means that the cost of this discount can be annualized as 1% * 365/20 = 18.25%.

This means that if the firm chooses not to take advantage of the trade discount offered, it is actually losing 18.25%. per annum.

20.13%

Explanation:

Effective Annual Cost = (1 + Discount / (100 - Discount))^(365/(Payment Days - Discount Period)) - 1. Where Discount = 1, Payment Days = 42 and Discount Period = 22

Effective Annual Cost = (1+1/(100-1))^(365/(42- 22)) - 1

Effective Annual Cost = (1+0.01010101)^18.25 - 1

Effective Annual Cost = 1.01010101^18.25 - 1

Effective Annual Cost = 1.20131720725 - 1

Effective Annual Cost = 0.20131720725

Effective Annual Cost = 20.13%

So, 20.13% is the effective annual cost to my firm if it chooses not to take advantage of the trade discount offered.

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