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

Meera Industries buys on terms "2/10, net 45" (360-day year). Its bank charges 20% p.a. If it stretches payment to 70 days, ignoring any penalty, what is the cost of forgoing the discount, and what is the decision, versus the 20% bank rate?

Meera should forgo the discount and pay on day 70. Stretching payment to 70 days gives 60 extra days, so the implicit cost is 2/98 times 360/60, about 12.24%, which is below the 20% bank rate, making bank borrowing to claim the discount costlier.

  1. AAbout 12.24%; forgo the discount and pay on day 70Correct
  2. BAbout 12.24%; take the discount and borrow
  3. CAbout 12.24%; pay on day 45 as that is the net period
  4. DAbout 24.49%; take the discount and borrow

Explanation

Stretching to day 70 gives 60 extra days, so cost = (2/98) x (360/60) = 2.0408% x 6 = 12.24%. This is below the 20% bank rate, so borrowing to take the discount is dearer, and the firm should forgo the discount and pay on day 70. Option 3 uses 30 days (24.49%), the original net period, which is wrong when payment is stretched.

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