Dexter Products receives $25,000 worth of merchandise from its major supplier on the 15th and 30th of each month. The goods are sold on terms of 1/15,... Accounting MCQs | Accounting MCQs

Dexter Products receives $25,000 worth of merchandise from its major supplier on the 15th and 30th of each month. The goods are sold on terms of 1/15, net 45, and Dexter has been paying on the net due date and forgoing the discount. A local bank offered Dexter a loan at an interest rate of 10%. What will be the net annual savings to Dexter if it borrows from the bank and utilizes the funds to take advantage of the trade discount?

$(950)
$1,050
$7,050
$2,250Show Result

Correct - Your answer is correct.

Wrong - Your answer is wrong.

Detailed Answer

Answer (B) is correct. The annualized cost of not taking a discount can be calculated with the following formula: Cost of not taking discount = [1% ÷ (100% – 1%)] × [360 days ÷ (45 days – 15 days)] = (1% ÷ 99%) × (360 days ÷ 30 days) = 01.0101% × 12
= 12.1212% To take the discount, the firm can use a succession of loans to pay $49,500 ($50,000 × 99%) each month at a cost of $4,950 ($49,500 × 10% annualized rate). If it does not take the discount, it pays $6,000 per year ($49,500 × 12.1212% annualized rate) for a succession of 30-day loans. Thus, borrowing saves $1,050 ($6,000 – $4,950).