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

Iyer Foods is offered terms 3/10, net 40. It can borrow from a bank at 15% per annum. Using the simple 360-day formula, the cost of foregoing the discount is about 37.11%. Which decision is financially sound?

Iyer Foods should borrow from the bank and pay on day 10. Foregoing the 3% discount implicitly costs about 37.11% a year, which exceeds the 15% bank rate, so taking the discount with borrowed funds is cheaper.

  1. ABorrow from the bank and pay on day 10 to take the discountCorrect
  2. BPay on day 40, since trade credit is free
  3. CPay on day 10 using trade credit with no borrowing
  4. DPay on day 40 because the bank rate is higher than the discount cost

Explanation

Cost = 3/97 x 360/30 = 37.11%. Since bank borrowing at 15% is cheaper than 37.11%, borrow and take the discount. Paying late is not free because it forfeits the discount.

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