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CA Intermediate · Financial Management and Strategic Management · Management of Payables (Creditors)

Kapoor Ltd has annual purchases of Rs 7,20,000 (360 days), and a supplier offers '1/15, net 45'. Kapoor can borrow from its bank at 12% p.a. Using the simple cost formula, which decision is correct?

Kapoor should take the discount. Forgoing 1/15, net 45 costs (1/99) x (360/30), about 12.12% a year, which is higher than the 12% bank borrowing rate. Borrowing from the bank to pay early is therefore slightly cheaper than using the supplier's credit.

  1. ATake the discount, as the cost of foregoing it (about 12.12%) exceeds 12%Correct
  2. BForgo the discount, as the cost of foregoing it (about 12.12%) is below 12%
  3. CTake the discount, as the cost of foregoing it is about 8.1%, exceeding nothing
  4. DForgo the discount, as the cost of foregoing it is about 24.2%

Explanation

Cost = (1/99) x (360/30) = 0.010101 x 12 = 12.12%. Since this exceeds the 12% bank rate, it is cheaper to borrow and pay early, so take the discount. Option B misreads the comparison. Option D uses 360/15 giving 24.2%, a wrong period.

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