Northeast Baptist buys $500,000 of a particular item (at gross prices) from its major supplier, Cardinal Health, which offers NE Baptist terms of 3/20, net 60. Currently, the hospital is paying the supplier the full amount due on Day 60, but it is considering taking the discount, paying on Day 20 and replacing the trade credit with a bank loan that has a 12 percent rate.
a. What is the amount of free trade credit that Baptist obtains from Cardinal Health? (Assume 360 days per year throughout this problem.)
b. What is the amount of costly trade credit?
c. What is the approximate annual cost of the costly trade credit?
d. Should Baptist replace its trade credit with the bank loan? Explain your answer.
e. If the bank loan is used, how much of the trade credit should be replaced?