Question

The Reynolds Corporation buys from its suppliers on terms of 2/12, net 45. Reynolds has not been utilizing the discounts offered and has been taking 45 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 11 percent compensating balance on these loans. Current account balances would not be available to meet any of this compensating balance requirement.

Required:
a. Calculate the cost of not taking a cash discount.
b. Calculate the Effective rate of interest if the company borrow from the bank.

Answer 1

A. 22.56%

B. 17.97%

Step-by-step explanation:

a. Calculation for the cost of not taking a cash discount.

Cost of not taking cash discount = ( 2% / 98% )* ( 365 / (45 - 12) )

Cost of not taking cash discount=0.0204*365/33

Cost of not taking cash discount=7.446/33

Cost of not taking cash discount=0.2256*100

Cost of not taking cash discount= 22.56%

Therefore the Cost of not taking cash discount will be 22.56%

b. Calculation for the rate of interest if the company borrow from the bank.

Annual rate of interest = 16% / (1- 11%)

Annual rate of interest = 0.16/0.89

Annual rate of interest = 0.1797*100

Annual rate of interest = 17.97%

Therefore the rate of interest if the company borrow from the bank will be 17.97%