Question

Springbok Face Apparel manufactures embroidered protective face coverings. Seeing how lucrative this market is, due to the legislative requirement for everyone to wear protective face coverings while outdoors, Jumbo Fabrics, an existing supplier, has offered Springbok Face Apparel credit terms of 3/10 net 30 EOM. Having been approached with similar offers from prospective suppliers, Springbok Face Apparel believes that it can stretch its credit period (net period only) with Jumbo Fabrics to 38 days without damaging its credit standing. Assuming Springbok Face Apparel has a credit line available at a local bank at an interest rate of 15%, the firm should:

	A.	give up the cash discount and pay on the last day of the credit period.
	B.	give up the cash discount and finance the purchase with the line of credit by paying within 68 days of the credit period.
	C.	take the cash discount and finance the purchase with the line of credit, the cheaper source of funds.
	D.	take the cash discount and pay on the last day of the cash discount period.

Answer 1

Let us assume that the firm makes a purchase of $10000 and requires the financing for a period of 1 year before it can pay for evaluating all alternatives

A. If the firm pays on the last day of credit period ie.. 30th day, it has to take financing @15% for remaining 365-30 = 335 days

Net amount paid after 1 year = 10000* (1+0.15*335/365) = $11376.71

B. if the firm stretches and pays wihin (it is best to pay on the last day) , the firm has to arrange financing for the remaining (365-68 =297 days)

Net amount paid after 1 year = 10000* (1+0.15*297/365) = $11220.55

C. If the firm takes the cash discount and finances the remaining amount at 15% for 365 days

Amount paid = $10000 * (1-0.03) = $9700

Net amount paid after 1 year = 9700* (1+0.15) = $11155.00

D.

If the firm takes the cash discount (by paying on 10th day) and finances the remaining amount at 15% for 355 days

Amount paid = $10000 * (1-0.03) = $9700

Net amount paid after 1 year = 9700* (1+0.15*355/365) = $11115.14

So, Option D is the best one,

One should take the cash discount and pay on the last day of the credit period and then take the financing if required.