The price offered to coffee growers who turn in their “cherries” — ripe coffee beans — at Greenwell Farms in Kona, Hawaii, is $.90 per pound if they are paid weekly and $1.05 if paid monthly.
The weekly price is lower because it takes the company’s accountants more time to work out and record pay if they do it weekly rather than once a month. But what does this price differential imply about the grower’s discount rate? If he takes the weekly rate, on average he is getting $.90 one-half month earlier than he would get $1.05.
That implies an annual discount rate of nearly 4,000 percent — (1.05/.90)^24 – 1 — a truly remarkable rate of impatience. Despite this, the tour guide tells me that a lot of growers do take the lower rate of pay.
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The logic of the farmers taking the weekly pay is the same as the logic of the U.S. corporations that sell their Accounts Receivable to factoring companies in return for an immediate payment that’s discounted from the full value of the A/R. They need the immediate cash flow to cover expenses.
It’d be interesting to do the same calculations for, say, a major railroad’s factoring program.
@6:
>> the poor are stupider and more impulsive with money than the wealthy.
This is true, sadly. Wonder how many poor people you know. Lottery tickets, get rich quick scams, stupidly changing deductions to as to minimize tax on the Christmas paycheck (never mind you have to figure out how to pay for that later).
When I calculate the discount as an engineer, without fancy economic theory, I get a 11% discount for selling weekly vs. selling monthly.
@11
It’s a 17% advantage at time of sale (1.05/.90). But that’s a rate for getting money on average 2 weeks ahead of time. Now compound that over the course of a year to get an APR. Much bigger.
One might also wonder about storage and transportation limits. If I can only store one weeks worth of beans, I can’t take advantage of the monthly rate without serious infrastructure investment.
I agree very much with Andrew, except to note that there is certainly a deeper behavioral component, wherein the poorer folks who so often make such decisions don’t properly assess how they can get beyond their constant need for something tangible now.
Their fault? Not really, when you consider that even the average person is often duped into overpriced financing schemes on a regular basis. And then compound this with a scenario in which one’s bank accounts can be immediately depleted by a small emergency, and they never have a chance to “catch up.”
Living in Arizona, our payday loan industry comes to mind as analogous to this story. When voters recently turned down the right for these businesses to charge usurious rates of interest (like… 40%), there was a lot of questioning as to how people could even justify the pitfalls of such loans. To put it simply, it mostly comes down to the inability to build credit and find cheaper money, as so many of us do — and the short-term nature of the loan, which obscures its true cost. When you live hand-to-mouth, unexpected expenses can cause serious problems even for those who are working on the luxury of greater financial stability. And if you spend a little too much just once, or forgo just a little extra profit/savings, then what’s the big deal.
How many pounds of beans comprise a typical transaction? 10 pounds? 100 pounds? 1000 pounds?
We have a somewhat similar situation at my employer, an over the road trucking company. We give our employee drivers the ability to use their company fuel cards to take cash advances in the event they need unexpected cash for personal expenses while on the road. The idea is to help provide a safety net for our drivers while they are on the road. The 3rd party company that provides these advances charge a fee and usually the truck stop that process the transaction charges a fee as well. This is similar to using your ATM card at a different bank. The total for the fees range from $5 to $6.50 PER transaction. Quite a few of our drivers take cash advances every week despite my repeated pleas to them to manage their money better. These are folks that earn above average incomes, are paid weekly, and have been shown on paper that it’s costing them hundreds of dollars a year in wasted fees, yet many are perfectly willing to give their hard earned money up each week in order to get their money faster.