Question

Chapter 16 Problem 1

1. A supplier is offering your firm a cash discount of 2 percent if purchases 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

First, the rate obtained from the company should be calculated and then it should be compared with the borrowing rate from the bank.

Rate of return= Amount repaid/ Amount borrowed -1

                           = Price/ Price*(1- discount)

                           = 1/1*(1-0.02) -1

                           = 0.0204 2.04%

The 50 day rate must be annualized as below:

Rate= (1+0.0204)^365/50 -1

        = 1.0204^7.3 -1

        = 1.1588 -1 = 0.1588 15.88%.

The rate obtained from the company of 15.88% is lower than bank borrowing rate of 18%. Therefore, I recommend to not taking the discount.