A supplier to your firm offers credit terms of 2/15 net 45 however, yo

A supplier to your firm offers credit terms of 2/15 net 45 however, your firm never takes advantage of the discount but instead always pays full price on day 45.

Your finance intern claims that your firm would be better off borrowing money from an existing but little used line of credit at a current annualized rate of 8%, pay the firm providing credit at the end of the discount period (day 15 ) and to then repay the line of credit 30 days later on day 45. She argues that the cost to your firm would be lower than current practice. What is the effective cost to the firm of not utilizing the discount vs, the cost of borrowing money to take advantage of the discount? Please show your work and provide your answers in percentage terms.

ANSWER

Taking the discount has an annualized rate of 8% as stated. The cost of foregoing the discount is ($20/$980 ) * (365/30 ) = 24.83% or a difference of $248.30 – $80 = $168.30 annually for each $1,000 of trade credit provided by the supplier.