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Can you please explain the answer to this question please? I have no idea where the 6 comes from?
Swap co is due to receive goods costing $2,500. The terms of trade state that payment must be received within three months. However, a discount of 1.5% will be given for payment within one month.
Which of the following is the annual percentage cost of ignoring the discount and paying in three months?
You have not told me where the question comes from (is it a past exam question? Is it a question from the BPP Revision Kit?) and so how do you expect me to explain the answer? 🙂
I can only assume that the 6 you are referring to is the 6 used in converting the 2 months effective rate into an annual effective rate.
The discount is given for payment within 1 month instead of 3 months – so 2 months early.
So you can calculate the effective 2 month rate.
There are 6 periods of 2 months in a year, so we have to take it to the 6th power in order to calculate the 12 months effective rate.Do watch my free lectures on the management of receivables where I work through examples like this.
The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
HELLO sir, this is from december 2016 CBE practice questions on the official platform.
the explanation is
If the discount is accepted, the company must pay $2,462.50 at the end of one month.
Alternatively, the company can effectively borrow the $2,462.50 for an additional two months at a cost of $37.50.
The two month rate of interest is therefore 37.50/2,462.5 x 100 = 1.5228%
The annual equivalent rate (AER) is therefore:
(1 + 0.015228)6 – 1 = 0.0949 or 9.49%
what I cant figure out is where the borrowing cost came from, maybe i’m missing something basic but no value of Borrowing cost is available in the question.
The invoice is for 2,500.
If they take the discount then the only pay 2462.50.
So not taking the discount means they will have to pay an extra 37.50 which is like borrowing 2462.50 for two months and having to pay 37.50 interest.
Have you watched my free lectures on the management of receivables and payables (because I think my explanation is more understandable than the way the ACCA have explained it 🙂 )
The Annual Equivalent Rate (AER) is a measure used to calculate the annual interest rate on an investment or loan, taking into account compounding. It allows for easy comparison of different investment or loan options.
The formula to calculate AER depends on the compounding frequency and the nominal interest rate.For example, if the nominal interest rate is given on a monthly basis, the AER can be calculated using the formula:
AER = (1 + r/n)^n – 1, where r is the nominal interest rate and n is the number of compounding periods per year. It is important to note that the AER assumes that the interest is reinvested or compounded.
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