Calculating the Nominal Annual Cost of Trade Credit

Problem Overview

Scenario: Coyote Company buys from suppliers with terms 3/12 net 30.
Discount Terms: Pay within the first 12 days to receive a 3% discount.
Goal: Calculate the nominal annual cost of trade credit if Coyote Company pays on the 30th day.
Additional Questions:
- What is the worst day to pay?
- What is the best day to pay?

Formula:
- Nominal Annual Cost = (Discount Percentage / (100 - Discount Percentage)) * (365 / (Days Outstanding - Discount Period))
Explanation:
- Calculates the cost of foregoing a discount over an annual period.

Terms Analysis:
- Pay within 12 days = 3% discount.
- Pay after 12 days = full price, must pay by 30 days.
Nominal Annual Cost Calculation:
- Discount Percentage = 3%.
- Days Outstanding = 30 days.
- Discount Period = 12 days.
- Substitute into formula:
  - (3 / (100 - 3)) * (365 / (30 - 12))
  - Solve: 0.030928 * 20.2778 = 0.6272 or 62.72%
Interpretation:
- Paying on the 30th day incurs a penalty equivalent to borrowing at approximately 63% annually.

Calculation for 20th Day:
- Days Outstanding = 20 days.
- Substitute: (3 / (100 - 3)) * (365 / (20 - 12))
- Solve: 0.030928 * 45.625 = 1.4111 or 141.11%
Conclusion:
- Paying on the 20th day results in a 141% annual cost.
- Worst Day: Day 13
  - Missing discount but only gaining 1 day results in the highest cost.

Analysis:
- Pay by Day 12 to receive the discount.
- Day 12 allows maximum usage of cash while still obtaining the discount.
Conclusion:
- Best Day: Day 12
- Delays cash outflow while securing the lower price.

Optimal Strategy:
- If missing the discount period, pay on the last possible day (Day 30) for minimal cost.
- For best financial outcome, pay on Day 12 to take full advantage of the discount without penalty.

Practice solving similar problems to solidify understanding of trade credit calculations.