Annual % Cost of a discount

MattW

Hi all,

I've been asked to work out the annual % cost of a discount and have been given the following information:

Average customer invoices = £3000
Normal payment terms = 90 days
Proposed discount of 2% for payment in 30 days.

I haven't got the answer to the question, but I just want to double check the method I am using:

I am going to use the annual cost of a discount calculation from my book =

d/(100-d) X 365/(N-D)

where:

d= discount given (%)
N= Normal Terms
D= Discount Terms

I can put all my figures in, but I can't work out where to put the figure for average invoice value of £3000 (or has this been put in the question to confuse me??)

Many thanks

Matt

PS forgot to put my answer in - i get 12.42%

visha

My calculations are as follows

3000 x 2% = £60 discount given for 60 days early settlement

therefore £60 divide by 60days times 365 days for annualised cost = £365

£365 divide by (3000 - 60) £2940 capital amount times 100 equals 12.415%

therefore I agree with your answer

MattW

Thanks vishia, I haven't seen that way of calculating before, but can see how it works - where did you learn it?

I don't have that method in my Kaplan books.

But I am glad we agree!

Cheers

Matt

SandyHood

Both methods are fine. Effectively they are the same the same method but I can understand that putting a value in can make it more realistic.

This is my answer to an earlier posting asking the same question

http://www.aat.org.uk/forums/showthread.php?t=17016

There is one point that is worth pointing out (although I feel that producing a compound rate of interest on an accounting course equivalent to NVQ level 3 is perhaps questionable)

Normal payment terms = 90 days
Proposed discount of 2% for payment in 30 days.

The % saving is 2/98
The number of periods in the year are 365/(90-30)

So the savings rate can be compounded to get a more precise annual equivalent rate. Which we would expect to be slightly more than the simple interest rate.
..2 +1 to the power of the number of periods (.365)
.98..........................................................60

This gives a rate of 13.08%

I am aware that this topic is being tested in the skills test (hence all the threads on here!!) but I consider that the following answers would both be considered evidence of copmpetence.

1. 12..42% at a simple rate (which would be slightly lower than a compound equivalent) for candidates with calculators with no button to enable "to the power" calculations.
2. 13.08% is the annual percentage rate equivalent
   
   
   for a discount of 2% for customers who previously took 90 days to pay, now paying in 30 days.