Question

A supplier is offering your firm a cash discount of 2 percent if purchase are paid for within ten days : otherwise the bill is due at the end of 60 days. Would you recommend borrowing from a bank at an 18 percent annual interest rate to take advantage of the cash discount offer? Explain your answer,

Answer 1

The trade terms are 2% discount for payment in 10 days or pay the invoice value in 60 days. We calculate the cost of discount and if it is more than 18% (annualised) then it would be beneficial otherwise not.

Let us assume that the invoice value is $100. Then if the payment is made within 10 days (we take it is made on day 10):

• Discount of $2, then the payment to be made is $98 hence savings of $2.
• The interest cost on $98 for 50 days (from day 10 to day 60) : 98 * 18% * 50 / 365 = 2.42

Since the interest cost for 50 days at 18% is more than the discount, it is better for the firm to pay at the end of 60 days instead of going for the discount.