Question

The Reynolds Corporation buys from its suppliers on terms of 3/15, net 55. Reynolds has not been utilizing the discounts offered and has been taking 55 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 16 percent. The bank requires a 14 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.) 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.) c. Do you agree with Duke's proposal? Yes No

Answer 1

a) 27.83% annual rate

b) 18.60%

c) Yes, as the bank annual rate is lower than supplier rate.

Step-by-step explanation:

we calculate for rate considering how interest are calculated

principal x rate x time = interest

the net of discount will be the principal, the interest the discount and time:

55- 15 = 40 days the interest start from the day after last day of the discount period until 55 days thus 40 days the amount generates interest

over 360

0.97 x rate x 40/360 days = 0.03

rate = 0.27835 = 27.83%

b) the loan give provides at 14% but 16% of these amount is keep as compensating balance therefore; real interest rate is:

`(interest)/(1-C) =(0.16)/(1-0.14) =0.1860`