Hochschule RheinMain University of Applied Sciences

Wiesbaden Business School

Master of Arts in International Management (MIM)

72212 (PO 2016) International Capital Structure
Slide I.14, Berk/DeMarzo (2014), p. 891, Example 26.2
I Working Capital Managemement
Example: Estimating the Effective Cost of Trade Credit

Assumptions
Trade credit, terms of 1/15, Net 40 Berk/DeMarzo (2014), 3rd edition Trade credit, terms of 2/10, Net 30
Invoice amount for purchase of goods 100.00 $ Alternative parameters
Trade discount s= 2% 2% 1%
First days for a zero-interest loan 10 days 10 15
Term to pay invoice for purchase of goods 30 days 30 40

Solution for an annual percentage rate with simple interest 1 + d·r

Loan amount 98.00 $
Interest 2.00 $
Term of the loan 20 days
Day count fraction A/365 d= 0.0548
1/d = 18.2500
Effective annual rate r = s/(1-s)*1/d
= 0,0204*18,25
= 0.3724
= 37.24%

Loan amount plus interest = 98·(1+d·r)

= 98·(1+0,02040752)
= 98·1,0204
= 100.00 $

Solution for an annual percentage rate with compounded interest (1 + r)^d

Loan amount 98.00 $
Interest 2.00 $
Term of the loan 20 days
Day count fraction A/365 d= 0.0548
1/d = 18.2500
Effective annual rate r = 1/(1-s)^1/d - 1
= 1,0204^18,25 -1
= 1,4459 -1
= 44.59%

Loan amount plus interest = 98·(1+r)^d

= 98·(1+0,4459)^0,0548
= 98·(1,4459^0,0548
= 98·1,0204
= 100.00 $