Question

Langley Clinics, Inc., buys $400,000 in medical supplies each year (at gross prices) from its major supplier, Consolidated Supplies, which offers Langley terms of 2.5/10, net 45. Currently, Langley is paying the supplier the full amount due on day 45, but it is considering taking the discount, paying on day 10, and replacing the costly trade credit with a bank loan that has a 10 percent annual cost.

Required:
a. What is the amount of free trade credit that langley obtains from Consolidated Services?(assume 360 days per year throughout this problem)
b. What is the amount of costly trade credit?
c. What is the approximate annual cost of the costly trade credit?
d. Should Langley replace its trade credit with the bank loan? explain your answer.
e. If the bank loan is used, how much of the trade credit should be replaced?

Answer 1

Step-by-step explanation:

a. What is the amount of free trade credit that langley obtains from Consolidated Services?

Since there's a 2.5% discount, amount paid will be:

= $400000 - (2.5% × $400000)

= $400000 - $10000

= $390000

The amount of free trade credit that langley obtains from Consolidated Services since payment was made within 10 days will be:

= ($390000/360) × 10

= $1083 × 10

= $10833

b. What is the amount of costly trade credit?

Assuming Langley pays by day 45, the increase in its accounts payable will be:

= 45 x $1,083

= $48,735

Therefore, the amount of costly trade credit will be:

= Total trade credit – Free trade credit = $48,735 – $10,833

= $37,902

c. What is the approximate annual cost of the costly trade credit?

The percentage cost will be:

= 10000 / 37902

= 26.38%

d. Should Langley replace its trade credit with the bank loan?

Langley should replace the trade credit with a bank loan if it can get a bank loan that's can less than 26.38%, then the trade credit of $37902 should be replaced.

e. If the bank loan is used, how much of the trade credit should be replaced?

Only the trade credit of $37902 should be replaced.