Answer (D) is correct . Terms of 1/10, net 60 mean that a buyer can save 1% of the purchase price by paying 50 days early. In essence, not taking the discount results in the buyer’s borrowing 99% of the invoice price for 50 days at a total interest charge of 1% of the invoice price. Because a year has 7.3 50-day periods (365 ÷ 50), the credit terms 1/10, net 60 yield an effective annualized interest charge of approximately 7.37% [(1% ÷ 99%) × 7.3]. If the prime rate were higher than 7.37%, the buyer would prefer to borrow from the vendor (i.e., not pay within the discount period) rather than from a bank. Consequently, an 8% prime rate could cause the vendor’s receivables to increase.
Answer (A) is incorrect because The prime rate must be greater than 7.37% to make the company’s terms preferable to those of a bank.
Answer (B) is incorrect because The prime rate must be greater than 7.37% to make the company’s terms preferable to those of a bank.
Answer (C) is incorrect because The prime rate must be greater than 7.37% to make the company’s terms preferable to those of a bank.
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