Question

A company currently takes 45 days credit from suppliers on the basis that this is 'free' finance.Annual purchase are k20million and the company pays over draft interest of 15%.Payment within 15 days woukd attract 2.5% quick settlement discount.

Required: Advice whether the company pay sooner in order to take advantages of the discount of not

Answer 1

Total annual purchase are = $20 million

If company pays within 15 days, it gets discount = 2.5% * 15,000,000 = $375,000

Overdraft interest rate = 15%

Company takes total 45 days credit from the suppliers which is free

Assuming If company pays on day 15 then it will loose 30 days of free credit.

Here company will have raise money through overdraft and pay the 15% annulized interest

Interest on $15 million overdraft for 30 days = 15,000,000 * 15% * 30/365 = $184,932

Since the discount for early payment of $375,000 is higher than overdraft interest payment of $184,932 for 30 days, company should pay sooner to take the advantage of 2.5% discount.