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Hayes Corp
Hayes Corp. purchases $365,000 in goods over a 1-year period from its sole supplier. The supplier offers trade credit under the following terms: 2/10, net 30 days. Hayes finally chooses to pay on time (pay in the 30th day) but not to take the discount. We assume 365 days per year.
1) What is the average level of the company's free trade credit?
2) what is the average level of the company's costly trade credit?
3) what is the average level of the company's total trade credit?
4) what is the nominal annual cost of the firm's costly trade credit?
5) what is the effective annual cost of the firm's costly trade credit?
Expert Solution
1) Computation of the free trade credit:-
Free trade credit = (Total credit purchases in a year / 365) * Number of days of free trade
= ($365,000 / 365) * 10
= $1,000*10
= $10,000
2) Computation of the average level of the company's costly trade credit:-
Costly trade credit = (Total credit purchases in a year / 365) * Number of days after discount
= ($365,000 / 365) * (30 -10)
= $1,000 * 20
= $20,000
3) Computation of the average level of the company's total trade credit:-
Total trade credit = (Total credit purchases in a year / 365) * Total number of days
= ($365,000 / 365) * 30
= $1,000 * 30
= $30,000
4) Computation of the nominal annual cost of the firm's costly trade credit:-
Nominal cost of trade credit = (Discount % / (1 - Discount %)) * (365 / (Number of days credit availed - Number of days of free trade))
= (2% / (1 - 2%)) * (365 / (30 - 10))
= 2.0408% * 18.25
= 37.24%
5) Computation of the effective annual cost of the firm's costly trade credit:-
Effective annual cost trade credit = (1+(Discount %/(1-Discount %)))^(365/(Number of days credit availed-Number of days of free trade))-1
= (1+(2%/(1-2%)))^(365/(30-10)) -1
= (1.02041^18.25) -1
= 1.4459 - 1
= 44.59%
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