# Effective annual interest rate

Guys a quick question on accounts payable managment: Your company purchased \$10,000 worth of inventory on January 2nd on credit. The terms of the sale are 3/15 net 45. What is the effective annual interest rate if you pay the full amount in 45 days? A. 28%. B. 37.6%. C. 44.9%. D. 74.3% C: (1 + 0.03/0.97)(365/30)-1 = 0.4486 or 44.86% I understand the calculations, but what us ut telling us? Thanks

Check on page 120-121 of the CFAi text, it is the implicit rate of return represented by the trade discount offer. Equivalent return to the customer of an alternative investment. It is 0 in the discount period, jumps up immediately after the discount period, to calm down and reduce as the payday comes. Beyond the payday deadline, you’ll probably have to deal with supplier’s dissatisfaction, which could have an adverse impact on your business relations.

Thanks Map, i read the text however i’m still finding it hard to understand. It states that if paid within 10 days a 2% discount is given and the net amount is due by the 30th day. But i thought we paid within the 10 days? ,why is the net amount due by the 30th?

To your problem above, it says: if you pay within 15 days, you’ll get a 3% discount off of the amount billed. If you do not pay within these 15 days, you have until the 45th day to pay the entire amount billed, you will not have a discount on it.

Agreed, but what does the 44.86% mean, did i forego a short term investement return of 44% ? I’m sorry but i just can’t seem to grasp it, perhaps because i’ve skipped a few pages in my hast to ready for the exam, my own wrong doing, but i feel i’m not going to finnish other wise. : /

It is the forgone opportunity of the discount. Sort of like (not exactly, but almost) saying, you have an investment that gives you 3% in 15 days. You don’t take it. What is its cost on an annual basis?

Oh, and your formula has an error, it is (1+3%/97%)^(365/30)-1

Aaah, Brilliant!! Thanks dude. : )