cost of trade credit

Suppose that the credit terms are 2/10, net 30: you get a 2% discount if you pay within 10 days, otherwise, the total amount is due in 30 days. You can think of the price as 98% of the total, and the interest at 2% of the total; thus, your effective interest rate for 20 days (= 30 – 10) is 2.0408% (= 2% / 98%). You compound that to get the annual rate:
cost of trade credit = (1 + (discount % / (1 – discount %))^(365/days past discount) – 1
In this example,
cost of trade credit = (1 + (2% / 98%))^(365/20) – 1
= 44.59%.
 
Cool! Thanks a lot. Still, not very intuitive. (How would effective intr rate for 20 days be 2/98; that 98 price was valid only for 10 days; not after that)
I am not applying my brain :(
 
blackjack21 wrote:Cool! Thanks a lot. Still, not very intuitive. (How would effective intr rate for 20 days be 2/98; that 98 price was valid only for 10 days; not after that)
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Think of paying the total on day 30 this way: you pay 98% on day 10 (taking advantage of the discount), then borrow that 98% back for 20 days (so your cash flow on day 10 is zero); after 20 days you have to pay 100%, or 2% more, on a loan of 98%.
 
Discount Percent/100 - Discount percent X 365/Days Credit is outstanding - Discount period = Cost of Not Taking the Discount.
Cost Of Trade Credit is called Cost of Not Taking the Discount.
For Example: Let’s say that your company is offered terms of trade of 2/10, net 30.This means that the supplier will offer you a 2 percent discount if you pay your bill in 10 days.Now, we have to imagine a scenario where your company is not able to take that 2 percent discount.What is this going to cost u ?
Using our example:
2/100 -2 X 365/30 - 10 = 37.2%
 
edupristine wrote:Discount Percent/100 - Discount percent X 365/Days Credit is outstanding - Discount period = Cost of Not Taking the Discount.
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This formula is incorrect. It’s not compounding the cost; the formula that CFA Institute has in Corporate Finance compounds the cost.
 
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