A material supplier offers terms of either '1/15 net 45' or '2/10 net 30' on a $50,000 invoice. Which option provides the better effective annual interest rate for taking the discount?
Correct Answer
D) 2/10 net 30 is better
The 2/10 net 30 terms provide a better effective annual rate. This option gives 2% discount for paying 20 days early (30-10), while 1/15 net 45 gives only 1% discount for paying 30 days early (45-15). The 2/10 net 30 terms offer a higher percentage return for a shorter time period.
Why This Is the Correct Answer
Option B (2/10 net 30) provides a better effective annual interest rate because it offers a 2% discount for paying 20 days early (30-10=20), compared to option A which only offers a 1% discount for paying 30 days early (45-15=30). When calculating the effective annual rate, the 2/10 net 30 terms yield approximately 37.2% annual return, while 1/15 net 45 yields only 12.2% annual return. The higher percentage discount combined with the shorter time period makes option B significantly more attractive financially.
Why the Other Options Are Wrong
Option B: Neither discount should be taken
Option A is incorrect because 1/15 net 45 provides a lower effective annual interest rate (12.2%) compared to the 2/10 net 30 option (37.2%). While you save money by paying early, you're getting less return on your early payment.
Option C: 1/15 net 45 is better
Both discounts should be taken if cash flow allows, as both provide positive returns that exceed typical borrowing costs. However, if choosing between them, the 2/10 net 30 is clearly superior.
Memory Technique
Think 'Big discount, Short time = Better deal' - the 2% discount in 20 days beats 1% discount in 30 days every time.
Reference Hint
Look up 'Trade Credit Terms' and 'Cash Discount Calculations' in business finance or construction accounting sections of your reference materials.
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