Question

Purchases made on credit are due in full by the end of the billing period. Many firms extend a discount for payment made in the first part of the billing period. The original invoice contains a type of “short-hand” notation that explains the credit terms that apply.

a. Write the short-hand expression of credit terms for each of the following.

Cash discount Cash discount period Credit period Beginning of credit period

1% 15 days 45 days date of invoice

2 10 30 end of month

2 7 28 date of invoice

1 10 60 end of month

b. For each of the sets of credit terms in part a, calculate the number of days until full payment is due for invoices dated March 12.

c. For each of the sets of credit terms, calculate the cost of giving up the cash discount.

d. If the firm’s cost of short-term financing is 8%, what would you recommend in regard to taking the discount or giving it up in each case?

Answer 1

Ans 1. a.

• 1/15 net 45 dates of invoice
• 2/10 net 30 EOM
• 2/7 net 28 dates of invoice
• 1/10 net 60 EOM

Ans 1.b.

• 45 days of the invoice
• 20 days balance of the month from March 12 to March 31 +30 days credit=50 days
• 28 days of the invoice
• 20 days balance of the month from March 12 to March 31 +60 days credit=80 days

Ans 1.c.

• Cost of giving up cash discount=cash discount/100%-Cash discount X365/Number of days

Cash discount =1%

Number of days=45-15=30 days

• 1%/100-1%x365/30
• =0.0101x12.17
• =12.29%

• Cost of giving up cash discount=cash discount/100%-Cash discount X365/Number of days

Cash discount =2%

Number of days=20 days

• 2%/100-2%x365/20
• =0.0204x18.25=37.23%

• Cost of giving up cash discount=cash discount/100%-Cash discount X365/Number of days

Cash discount =1%

Number of days=28-7 days=21 days

• 1%/100-1%x365/21
• =0.0204x17.38=36.46%

• Cost of giving cash discount=cash discount/100%-Cash discount X365/Number of days

Cash discount =1%

Number of days=60-10 days=50 days

• 1%/100-1%x365/50
• =0.0101x7.3=7.37%

Ans 1.d. If the firm’s cost of short-term financing is 8%, what would you recommend in regard to taking the discount or giving it up in each case?

Terms	Cost up giving up the cash discount	Cost of short-term finance	Recommendation
1% 15 days 45 days date of invoice	12.29%	8%	Take the cash discount as the cost of giving it up is 12.29% which is higher than 8%
2% 10 30 ends of the month	37.23%	8%	Take the cash discount as the cost of giving it up is 37.23% which is higher than 8%
2% 7 28 dates of invoice	36.46%	8%	Take the cash discount as the cost of giving it up is 36.46% which is higher than 8%
1% 10 60 ends of the month	7.37%	8%	Give up the cash discount as this cost is 7.37% which is lower than the cost of borrowing