Question

A company bought a machine for 1.000.000 dollars with 2/10 net 45 days. if they chose to use a loan from the bank the interest rate would be %16. what is the cost of giving up a cash discount for the company ? is it better to use bank loans , why ? ( 1 year=360 days)

Answer 1

Answer -

Q1 - Cost of giving up cash discount = $ 4,755.55

Q2 - Yes, using bank loan is a better option because we will he saving $4,755,55 by availing a 2% discount by borrowing at 16% per annum for 35 days.

Step -1

Company has 2 Options

Option 1 - It can pay 1,000,000 at the end of 45 days

Option 2 - It can avail the cash discount of 2% by paying at the end of 10th day by borrowing the required amount at 16% per annum for remaining 35 Days (Note we will borrow for 35 days because we are making payment after 10 days)

Step - 2 - Comparision of both the options

Option 1

Under option 1 total outflow at the end of 45 days = 1,000,000

Option 2

Under Option 2 company will avail the cash discount of 2% by paying at the end of 10th Day

Payment to be made = 1,000,000 * (100-2) = 980,000

to make the payment company will borrow 980,000 from the bank @16% per annum for 35 days

Interest for 35 Days = 980000 * 0.16 * 35/360 = 15244.44

Therefore at the end of 35 days company will have to repay 980000 + 15244 = 995244.44

Step - 3 Comparision of both the options

Outflow at the end of 45 Days under Option 1 = 1,000,000

Outflow at the end of 45 Days under Option 2 = 995244.44

Therefore cost of giving up cash discount = 1,000,000 - 995244 = 4755.55

Question 2 - Is it better to use bank loan?

Answer - Yes, using bank loan is a better option because we will he saving $4,755,55 by availing a 2% discount by borrowing at 16% per annum for 35 days.