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Date Posted: 10:43:54 02/13/02 Wed
Author: Dr. D.
Subject: Re: Cost of trade credit
In reply to: Mo 's message, "Cost of trade credit" on 07:37:32 02/12/02 Tue

The book makes a simplification to get across the concept. Here's the difference between the two formulas (using the example of 2/10, n30).

On a $100 purchase, you either pay $98 within 10 days, or $100 within 30. So, you would pay an additional $2 on a base of $98. On a percentage basis, this would be 2.04%. If it's not clear, think of a bank account where you started the year with $98 and ended it with $100. To calculate the interest, you would divide the $2 change by the $98, not by the $100 ending balance.

So, you pay an additional 2.04%. What do you gain? An additional 20 days to pay (the difference between 30 days and 10 days). If you assume a 360 day year (I know, that's a simplification too, but it makes the math easier), there are 360/20 = 18 "cycles" in a year. So, the annualized cost is 2/98 x 360/(30-10) = 36.73%. If you use a cost "per cylcle" of 2%, you would get a cost of 36%.

Hope this clears it up....




>In the book, (pg. 130), it says that the effective
>cost of not taking a discount (on terms of 2/10 net
>30) is calculated as
>(0.02)/(30-10) x 360
>
>But in class, the instructor (Dadalt) said that the
>correct calculationis
>
>2/98 x 360/(30-10).
>
>I'm confused - why are they different, and which one
>is correct?

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