Question

2. Which is a situation when a buyer should forgo an offered cash discount?

a. Firm invests in short-term funds that earn less than discount rate

b. Firm has insufficient cash to pay now but has short-term credit with lower interest rate than cost of not taking discount

c. Firm has ability to change discount terms by stretching A/P terms

d. The discount should never be foregone

Answer 1

Answer: Option c. Firm has ability to change discount terms by stretching A/P terms

Explanation: If the firm invests in short-term funds that earn less than the discount rate, it should liquidate the funds and utilize to make the payment and avail the cash discount. Hence a. is incorrect. If it has insufficient cash to pay now but has short-term credit with lower interest rate than the cost of not taking discount, it would be better to avail the credit at lower rate and utilize it to make the payment and avail cash discount since the cost of not taking discount is higher than the short-term credit rate. Hence b. is also incorrect. Discounts may be foregone if discount rate is lower than rate earned on short-term funds or if the cost of not taking discount is lower than the short-term credit rate. Hence d. is incorrect. Thus the cash discount should be foregone only if the firm has the ability to change discount terms by stretching A/P terms.