Question

Cash discount 4/20 net 35 by a creditor and the return is 9%

Which statement is true

Approximate cost of taking discount is 58.4% which is very hign

Discount should only be taking if cost of giving up the discount is less than return of 9%

Discount of 4% is less than required return of 9% discount should not be utilized

Cost of giving up discount is higher than the required return should not be used

Answer 1

In a scenario where suppliers provide an option for Cash Discount 4/20 net 35, you compare the cost of not availing the discount with the return you can earn on the money in that period.

Cash Discount 4/20 net 35 means that the payment date is after35 days but if you pay the supplier within 20 days, you will get 4% discount. If you pay after 20 days, you will not get any discount.

We will compare the 9% earnings on the payment amount against the additional amount we will pay (4%) if we make payment after day 20.

Let us assume that amount we have to pay to supplier is Rs. 100

Then if payment is made within 20 days, we will get a discount of 4%.

Discount Received = Discount Rate*Amount to be paid = 4%*100 = Rs. 4

Net payment if discount is availed = Gross Payment - Discount = 100 - 4 = Rs. 96

Therefore, to make the payment on 35th day instead of 20th day (i.e. for a period of 15 days), we will pay Rs. 4 more i.e. an interest of approx 4%.

On this amount, in 15 days, we can earn an amount = Principal Amt* Return Rate = 100*9% = Rs. 9 in a year

In a 15 day period (using cross multiplication), we can earn: 9Rs for 365 days,

XRs for 15 Days

X = (15*9)/365 = Rs. 0.37

Hence, the amount we earn on availing the discount (savings of Rs 4) is greater than the amount we can earn by not availing the discount (Rs. 0.37).

Correct Answer: Discount should only be taking if cost of giving up the discount is less than return of 9%