A material supplier offers terms of 1/15 net 45 on a $100,000 invoice. The contractor has sufficient cash flow to pay early. What is the annualized interest rate equivalent of taking this discount?
Correct Answer
B) 12.2%
The discount saves 1% by paying 30 days early (45-15=30). Annualized rate = (1% ÷ 30 days) × 365 days = 12.17%, which rounds to 12.2%. This represents an excellent return on investment for using available cash.
Why This Is the Correct Answer
Option C is correct because the calculation properly determines the annualized interest rate for early payment discounts. The formula takes the 1% discount rate, divides it by the number of days saved (30 days), then multiplies by 365 days to annualize it. This gives (1% ÷ 30) × 365 = 12.17%, which rounds to 12.2%. This represents the equivalent annual return the contractor earns by using cash to take the early payment discount.
Why the Other Options Are Wrong
Option A: 8.7%
Option D (15.3%) is too high and likely results from using an incorrect denominator in the calculation, such as using 15 days instead of 30 days for the early payment period.
Option C: 15.3%
Option A (8.7%) is too low because it likely uses an incorrect time period or fails to properly annualize the discount rate over the full 365-day year.
Memory Technique
Remember 'DDS': Discount ÷ Days Saved, then multiply by 365. The discount 'pays' you to use your cash 30 days early.
Reference Hint
Look up 'Cash Management' or 'Early Payment Discounts' in business finance sections of contractor reference materials
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A contractor estimates startup costs of $75,000 for equipment, $25,000 for initial inventory, $15,000 for insurance premiums, and $10,000 for working capital. They can finance 70% of the total. How much cash do they need?