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The Reynolds Corporation buys from its suppliers on terms of 3/11, net 40
The Reynolds Corporation buys from its suppliers on terms of 3/11, net 40. Reynolds has not been utilizing the discounts offered and has been taking 40 days to pay its bills.
Ms. Duke, Reynolds Corporation's vice president, has suggested that the company begin to take the discounts offered. Duke proposes that the company borrow from its bank at a stated rate of 20 percent. The bank requires a 15 percent compensating balance on these loans. Current account balances would not be available to meet any of this compensating balance requirement.
a. Calculate the cost of not taking a cash discount. (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Cost of not taking a cash discount
r
OA
b. What is the effective rate of interest on the bank loan? (Use a 360-day year. Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
Effective rate of interest
r
OA
Expert Solution
| a) Computation of Cost of Not Taking Cash Discount: | |||||||
| Cost of not taking cash discount = | Discount rate/(100%-discount rate)*(360/(Final due date-discount period)) | ||||||
| = | 3%/(100-3%)*(360/(40-11)) | ||||||
| = | 3%/97%*(360/29) | ||||||
| Cost of not taking cash discount = | 38.39% | ||||||
| b) Computation of Effective Rate of Interest: | |||||||
| Effective Rate of Interest = | Interest rate/(1-C) | ||||||
| = | 20%/(1-0.15) | ||||||
| Effective Rate of Interest = | 23.53% | ||||||
| c) | |||||||
| The effective cost of borrowing of 23.53% is lower than cost of not taking cash discount of 38.39% | |||||||
| Thus, company should borrow funds and avail discount | |||||||
| Yes, duke proposal is good. | |||||||
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