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CA Intermediate · Financial Management and Strategic Management · Financing of Working Capital

Bharat Polymers has an annual credit purchase of Rs 36,00,000 from a supplier offering 1/10, net 40. The firm can borrow from its bank at 12% per annum. Using a 360-day year and the simple cost formula, which is the better decision?

The firm should pay on day 10 and take the discount. Forgoing it costs (1/99) x (360/30), about 12.12% a year, which is higher than the 12% bank borrowing rate, so financing the early payment through the bank is cheaper.

  1. APay on day 10 and take the discount, since the implicit cost is about 12.12% against a bank rate that is lower
  2. BPay on day 40, since the implicit cost of the discount is about 12.12% against a bank rate of 12%
  3. CPay on day 10 and take the discount, since the implicit cost is about 12.12% which exceeds the 12% bank rateCorrect
  4. DPay on day 40, since the implicit cost of the discount is about 4.04% only

Explanation

Cost of forgoing = (1/99) x (360/30) = 0.010101 x 12 = 12.12%. Bank borrowing costs 12%, which is cheaper, so borrow from the bank and take the discount. Option 2 reverses the decision; option 1 misstates the comparison (12% is not higher); option 4 omits annualising.

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