Question

Your firm is offered credit terms of 3/20, net 55. what is the effective annual interest rate on this arrangement? assume 365 days per year.

a. 31.29%
b. 39.72%
c. 37.39%
d. 29.72%
e. 28.16%

Answer 1

The effective annual interest rate for the credit terms of 3/20, net 55, is 37.39%, calculated using the formula for annualizing the discount rate based on the terms provided.

Step-by-step explanation:

The effective annual interest rate for the credit terms offered, which are 3/20, net 55, can be calculated using the formula for the annualized interest rate based on the discount and the number of days the credit is extended beyond the discount period. The discount offered is 3%, and the discount period is 20 days, with the net period being 55 days. The formula to calculate the effective annual interest rate (EIR) is:

EIR = [(1 + (Discount Rate / (1 - Discount Rate)))^(365/Days Past Discount)] - 1

Plugging the values in:

EIR = [(1 + (0.03 / (1 - 0.03)))^(365/(55-20))] - 1

After calculating, the effective annual interest rate comes out to 37.39%, which is option c.