A construction company consistently pays suppliers within 10 days to earn a 2% early payment discount. If the normal payment terms are net 30, what is the annualized cost savings rate of this strategy?
Correct Answer
A) 36%
The 2% discount is earned by paying 20 days early (30-10=20). Annualized rate = (2% ÷ 20 days) × 365 days = 36.5%, which rounds to approximately 36%.
Why This Is the Correct Answer
Option B is correct because the annualized cost savings rate is calculated by determining how many times per year the 2% discount can be earned. Since payment is made 20 days early (30-10=20), this discount opportunity occurs 365÷20=18.25 times per year. Multiplying 2% × 18.25 = 36.5%, which rounds to 36%. This represents the effective annual return on the cash flow acceleration strategy.
Why the Other Options Are Wrong
Option B: 18%
12% is incorrect because it significantly underestimates the annualized rate, possibly from using monthly periods (12 per year) instead of calculating based on the actual 20-day early payment cycle.
Option C: 12%
24% is incorrect because it appears to use an incomplete calculation, possibly using 12 periods instead of the correct 18.25 periods per year, or using 360 days instead of 365 days in the calculation.
Option D: 24%
18% is incorrect because it represents only half the correct rate, possibly from dividing the final answer by 2 or miscalculating the number of discount periods available per year.
Memory Technique
Remember '2-20-365': 2% discount, divided by 20 days saved, times 365 days per year. The pattern is Discount/Days × Year = Annual Rate.
Reference Hint
Look up 'Cash Management' or 'Early Payment Discounts' in business finance sections, or 'Working Capital Management' chapters in construction business references.
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