Final answer:
If a customer foregoes a 1% discount on a firm's credit terms of 1/7 net 30, the effective annual rate of the credit extension can be calculated using the EAR formula considering the loan to be for 23 days. After calculating, the EAR must be rounded to two decimals to get the percentage rate.
Step-by-step explanation:
When a firm offers credit terms of 1/7 net 30, it means that the customer can take a 1% discount if they pay within 7 days, otherwise the full invoice amount is due in 30 days. If a customer does not take advantage of the 1% discount within the 7 days, effectively they are choosing to extend their credit by 23 days (30 days - 7 days) at a 1% increase in cost. To calculate the effective annual rate (EAR) on the credit extended, we use the following formula:
EAR = [(1 + i/n)^n] - 1
where i is the interest rate for the period, and n is the number of periods per year.
Since the customer effectively gets a loan for 23 days, the period interest rate will be i = 1% or 0.01. We express the year as 365 days, so the number of periods per year (n) is 365/23, and we plug these into the formula:EAR = [(1 + 0.01/(365/23))^(365/23)] - 1
After solving, we might find the EAR to be a certain percentage, rounded to two decimals, which gives us the effective annual rate for foregoing the discount