A material supplier offers terms of 2/10 Net 30. Your company typically pays invoices in 25 days. What is the annualized cost of not taking the early payment discount?
Correct Answer
A) 48.7%
Formula: (Discount % ÷ (100% - Discount %)) × (365 ÷ (Pay Period - Discount Period)). Calculation: (2 ÷ 98) × (365 ÷ 15) = 0.0204 × 24.33 = 0.497 or approximately 48.7% annualized cost.
Why This Is the Correct Answer
Option C (48.7%) is correct because it uses the proper formula for calculating the annualized cost of not taking an early payment discount. The formula accounts for the discount percentage, the remaining payment amount, and annualizes the cost based on how many discount periods occur in a year. When you don't take a 2% discount by paying 15 days later than the discount period, you're essentially paying 48.7% annual interest for that short-term financing.
Why the Other Options Are Wrong
Option B: 24.5%
36.7% is incorrect because it appears to be a rough approximation that might have used 360 days instead of 365 days in the calculation, or used an incorrect denominator in the discount percentage calculation.
Option D: 36.7%
73.5% is too high and likely results from an error in the formula application, possibly using the wrong denominator or incorrectly calculating the time period difference between the discount period and actual payment period.
Memory Technique
Remember 'D-R-A': Discount rate over Remaining percentage, times Annual periods. For 2/10 Net 30, think '2 over 98, times how many 15-day periods in a year' - this gives you the expensive cost of free money!
Reference Hint
Look up 'Trade Credit Terms' or 'Early Payment Discounts' in business finance sections, typically found in construction business management chapters dealing with cash flow and supplier relationships.
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