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Q: interest rate ( Answered 5 out of 5 stars,   0 Comments )
Subject: interest rate
Category: Business and Money > Accounting
Asked by: fatima1102-ga
List Price: $2.00
Posted: 10 Sep 2005 23:34 PDT
Expires: 10 Oct 2005 23:34 PDT
Question ID: 566670
A firm offers terms of 2/10, net 30. What effective annual interest 
            rate does the firm earn when a customer does not take the discount? 
            Assume a 360-day year.
Subject: Re: interest rate
Answered By: omnivorous-ga on 11 Sep 2005 07:26 PDT
Rated:5 out of 5 stars
Fatima1102 ?

Your question regards ?prompt payment discounts,? which are commonly
used in industry and result in phenomenal returns.  The format of
prompt payment discounts is generally:

Percentage discount / if paid within x days of invoice, OTHERWISE net in x days

So, your 2/10, net 30 is:

2% discount if paid in 10 days, otherwise due in 30 days

There?s a detailed discussion of ?how expensive? this is in trade
financing and specifics on its calculation in Slide 19 of this
presentation.  (Note that Pamela Hall uses a 365-day year in the
calculation ? and you?re using a 360-day year ? so results are
slightly different):

University of Toledo
?The Management of Working Capital? (Hall)

You?re getting a 2% discount on a 20-day advance in payments.
There are 18 20-day periods in a year.
Your discount is 18 x 2% = 36% per year.


In reality, prompt payment discounts are used to encourage businesses
(and governments) to pay early -- and not let the NET30 terms slip to
actual payments in 45 or 50 or 60 days.  They are particularly
effective with traditional "slow pay" customers such as government
agencies and school districts.

Google search strategy:
?prompt payment discount? 2%/10 net 30

Best regards,

fatima1102-ga rated this answer:5 out of 5 stars

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