CA Intermediate · Financial Management and Strategic Management · Financing of Working Capital
Kiran Ltd sells on terms of 2/10, net 40 and a customer pays on day 40 instead of taking the discount. Assuming a 360-day year, what is the approximate annual effective cost (simple basis, ignoring compounding) of forgoing the cash discount?
The approximate annual cost of forgoing the discount is 24.49%. It is computed as 2/98 multiplied by 360/30, because the customer gains 30 extra days of credit (40 minus 10) by giving up a 2% discount on a net payment of 98.
- A24.49%Correct
- B18.00%
- C12.24%
- D36.73%
Explanation
Cost = [Discount/(100 − Discount)] × [360/(Credit period − Discount period)] = (2/98) × (360/30) = 0.020408 × 12 = 24.49%. Using 2/100 gives 24.00%, and using 360/40 days gives lower figures; 18% and 12.24% come from mis-stated periods, such as using 180 days or 60 days.
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