The Reynolds Corporation buys from its suppliers on terms of 3/17, net 45. Reynolds has not been utilizing the discounts offered and has been taking 45 days to pay its bills. Mr. Duke, Reynolds Corporation vice president, has suggested that the company begin to take the discounts offered. Duke proposes that the company borrow from its bank at a stated rate of 16 percent. The bank requires a 20 percent compensating balance on these loans. Current account balances would not be available to meet any of this compensating balance requirement.
a. Calculate the cost of not taking a cash discount. (360 day year and 2 decimal places)
b. What is the effective rate of interest on the bank loan? (360 day year and 2 decimal places)
c. Do you agree with Duke’s proposal?