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CMA Intermediate · Financial Management and Business Data Analytics · Payable Management

Iyer Components Ltd has annual credit purchases of Rs 36,00,000 (360-day year). The supplier offers 1/10, net 30. The firm can borrow from its bank at 15% per annum. Which course of action is financially best, and why, using the simple annualised cost of forgoing the discount?

Take the discount and finance it with the bank loan. Forgoing a 1/10, net 30 discount costs about 18.18% annually, calculated as 1/99 times 360/20, which is higher than the 15% borrowing rate, so borrowing is cheaper.

  1. ATake the discount and borrow, since the cost of forgoing is about 18.18%, above 15%Correct
  2. BForgo the discount, since the cost of forgoing is about 9.09%, below 15%
  3. CForgo the discount, since the cost of forgoing is about 18.18%, above 15%
  4. DTake the discount and borrow, since the cost of forgoing is about 12.00%, below 15%

Explanation

Cost of forgoing = 1/99 x 360/20 = 18.18%. This exceeds the 15% bank rate, so it is cheaper to borrow and pay on day 10 to take the discount. The option claiming 9.09% uses 40 days wrongly, and the option that forgoes the discount reverses the comparison logic.

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