Question

Simple? Simon's Bakery purchases supplies on terms of 1.5/10, net 28. If Simple? Simon's chooses to take the discount? offered, it must obtain a bank loan to meet its? short-term financing needs. A local bank has quoted Simple? Simon's owner an interest rate of 10.2 % on borrowed funds. Should Simple? Simon's enter the loan agreement with the bank and begin taking the? discount? ? (Use 365 days for a? year.)

Answer 1

Solution:-

Effective cost of not taking discount

                   = (1+(r/(1-r))^(365/(Due date - discount period)) - 1

                   =((1+(0.015/(1-0.015)))^(365/(28-10)))-1

                    =35.86%

Hence the effective cost of not taking discount is greater than the bank interest rate (10.20%) . Hence Simple Simons should enter into agreement.

Note:- 1.5/10,net 28 means, if the payment is made within 10 days , a discount of 1.5% is offered . If the discount is not availed then the normal payment should be made within 28 days.

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