A material supplier offers early payment terms of 3/15 net 45 on a $40,000 invoice. If the contractor has sufficient cash flow, what is the annualized return on investment for taking the early payment discount?
Correct Answer
B) 36.5%
Discount = 3% for paying 30 days early (45-15=30). Annualized return = (0.03 ÷ 0.97) × (365 ÷ 30) = 0.0309 × 12.17 = 0.365 or 36.5%. This represents the effective annual interest rate earned by taking the discount.
Why This Is the Correct Answer
The correct answer is 36.5% because the calculation properly determines the annualized return on investment for early payment discounts. The formula accounts for the 3% discount earned by paying 30 days early (45-15=30), then annualizes this return by multiplying by the number of 30-day periods in a year. The calculation (0.03 ÷ 0.97) × (365 ÷ 30) = 36.5% represents the effective annual interest rate earned by taking advantage of the early payment terms.
Why the Other Options Are Wrong
Option A: 41.2%
24.3% is incorrect because it likely uses a simplified calculation that doesn't properly account for the compounding effect or uses 360 days instead of 365 days in the annualization factor.
Option D: 24.3%
41.2% is incorrect because it overestimates the return, likely due to an error in the calculation method or using incorrect time periods in the formula.
Memory Technique
Remember 'DAN': Discount over (1-Discount) × Annualization factor. The key is dividing by (1-discount rate) not just the discount rate, then multiplying by 365/days saved.
Reference Hint
Look up 'Cash Management' or 'Early Payment Discounts' in the Business and Finance section of your contractor reference manual, typically found in Chapter 4 or 5 dealing with financial management.
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