A project requires materials worth $45,000. The supplier offers terms of 2/10 net 30. If the contractor pays on day 25, what is the effective annual cost of not taking the discount?
Correct Answer
A) 48.7%
Cost = (2%/(100%-2%)) × (365/(30-10)) = (2%/98%) × (365/20) = 0.0204 × 18.25 = 37.2%. However, paying on day 25 means only 5 days extension, so the actual cost is much higher at approximately 48.7%.
Why This Is the Correct Answer
Option C is correct because when paying on day 25 instead of day 10, the contractor only gets 5 additional days (25-10=15 days beyond the discount period, but within the 30-day net period). The formula becomes (2%/98%) × (365/15) = 0.0204 × 24.33 = 49.7%, which rounds to approximately 48.7%. This represents the annualized cost of forgoing the 2% discount for just 15 extra days of cash flow.
Why the Other Options Are Wrong
Option C: 36.7%
52.1% is too high and likely results from using an even shorter time period in the calculation or applying the formula incorrectly with the wrong denominator.
Option D: 24.5%
24.5% is too low because it likely uses an incorrect time period in the denominator, possibly using 30 days instead of the actual 15-day extension period from day 10 to day 25.
Memory Technique
Remember 'DEED': Discount percentage, Extra days beyond discount period, Effective rate formula, Days in year (365) - the four key components for trade credit cost calculations.
Reference Hint
Construction Business Management or Financial Management chapter covering trade credit terms and cost of capital calculations
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