# TERMS OF SALE

## TERMS OF SALE

Otherwise,
the buyer has 40 days to pay the balance in full from the date of delivery.
In this case, the seller is off ering to lend the buyer money for an additional 30 days. How
expensive is it to the buyer to take advantage of this fi nancing? To calculate the cost, we need
to determine the interest rate the buyer is paying. In this case, the buyer pays 97 percent of the
purchase price if it pays within 10 days. Otherwise, the buyer pays the full price within 40 days.
Th e increase in the payment (and therefore the interest implicit in the loan) is 3/97  3.09
percent. Th is is the interest for 30 days (40-10). To fi nd the annual interest rate, we need to
compute the eff ective annual interest rate (EAR), which was introduced in Chapter 6. As you
recall, the EAR conversion formula accounts for the number of compounding periods and
thereby annualizes the interest rate.
Th e formula for calculating the the EAR for a problem like this is shown in Equation 14.4,
together with the calculation for our example. Notice that to annualize the interest rate, we
compound the per-period rate by the number of periods in a year, which is 12.1667 (365 days
divided by 30 days in a period).
The previous chapters dealt with long-term investment decisions
and their impact on fi rm value. These capital investment
decisions typically commit a fi rm to a course of action
for a number of years and are diffi cult to reverse. In contrast,
this chapter focuses on short-term activities that involve
cash infl ows and outfl ows that will occur within a year or less.
Examples include purchasing and paying for raw materials,
selling fi nished inventory, and collecting cash for sales made
on credit. These types of activities comprise what is known
as working capital management.