Asked by Denice Isidro on May 26, 2024
Verified
Peter O'Toole is a new accountant with First Step Company. First Step purchased merchandise on account for $18000. The credit terms are 2/10 n/30. Peter has talked with the company's banker and knows that he could earn 5% on any money invested in the company's savings account.
Instructions
(a) Should Peter pay the invoice within the discount period or should he keep the $18000 in the money market account and pay at the end of the credit period? Support your recommendation with a calculation showing which action would be best.
(b) If Peter forgoes the discount it may be viewed as paying an interest rate of 2% for the use of $18000 for 20 days. Calculate the annual rate of interest that this is equivalent to.
Discount Period
The time frame during which a payment made early is eligible for a discount according to the terms of the sales agreement.
Money Market Account
A type of savings account that typically offers both higher interest rates and greater withdrawal flexibility compared to regular savings accounts.
Annual Rate
Typically refers to the yearly interest rate or yield on a financial product or investment.
- Analyze the financial implication of payment terms and discount periods on cash management.
Verified Answer
MB
Maher BakhshJun 01, 2024
Final Answer :
Peter should pay the invoice within the discount period to save $310: (a)
Discount of 2% on $18,000$360 Interest received on $18,000 (for 20 days at 5% ) $50($18,000×5%×20÷360) Savings by taking the discount $310\begin{array}{lr}\text { Discount of } 2 \% \text { on } \$ 18,000 & \$ 360 \\\text { Interest received on } \$ 18,000 \text { (for } 20 \text { days at } 5 \% \text { ) } & \$ 50 &(\$ 18,000 \times 5 \% \times 20 \div 360)\\\text { Savings by taking the discount } & \$ 310\end{array} Discount of 2% on $18,000 Interest received on $18,000 (for 20 days at 5% ) Savings by taking the discount $360$50$310($18,000×5%×20÷360)
(b) The equivalent annual interest rate is:
2%×360÷20=36%2 \% \times 360 \div 20 = 36 \%2%×360÷20=36% .
Discount of 2% on $18,000$360 Interest received on $18,000 (for 20 days at 5% ) $50($18,000×5%×20÷360) Savings by taking the discount $310\begin{array}{lr}\text { Discount of } 2 \% \text { on } \$ 18,000 & \$ 360 \\\text { Interest received on } \$ 18,000 \text { (for } 20 \text { days at } 5 \% \text { ) } & \$ 50 &(\$ 18,000 \times 5 \% \times 20 \div 360)\\\text { Savings by taking the discount } & \$ 310\end{array} Discount of 2% on $18,000 Interest received on $18,000 (for 20 days at 5% ) Savings by taking the discount $360$50$310($18,000×5%×20÷360)
(b) The equivalent annual interest rate is:
2%×360÷20=36%2 \% \times 360 \div 20 = 36 \%2%×360÷20=36% .
Learning Objectives
- Analyze the financial implication of payment terms and discount periods on cash management.