If the prompt payment discount is foregone, which of the following credit terms implies the customer is borrowing at a rate that is less than 20% (assume 365 days per year)?
A)2/10, net 30
B)1.5/10, net 30
C)1/10, net 20
D)3/20, net 75
E)All of the above imply borrowing at 20% or more.

Question

Quizplus · Accepted Answer

The correct answer is D) 3/20, net 75. To determine the implied interest rate when a discount is foregone, we can use the formula: [(Discount %)/(100 - Discount %)] * (365/(Full Payment Period - Discount Period)). For option D, this would be [(3)/(97)] * (365/(75-20)) = 0.0309 * (365/55) = approximately 20.45%. However, this calculation was incorrect in determining that it's less than 20%. The correct approach to identify the annualized interest rate for each option should show that none of these options imply a borrowing rate less than 20% when the discount is foregone, as the calculation methodology typically results in a higher effective annual rate, especially for short discount periods. The mistake was in the calculation interpretation for option D. Upon correctly calculating the effective annual interest rate for each option, it's clear that each scenario results in an interest rate that is quite high, often exceeding 20%, when the prompt payment discount is not taken advantage of. The initial explanation mistakenly identified option D as having an interest rate below 20%, which was incorrect upon reevaluation. The correct interpretation should note that the effective interest rates for these scenarios are generally high due to the short duration between the discount period and the net period, making the cost of foregoing the discount significant.

If the Prompt Payment Discount Is Foregone, Which of the Following