Skip to content

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

Mehta Industries buys Rs 36,00,000 of raw material annually (360 days) on terms "2/10, net 40". A bank offers a loan at 14% p.a. The firm can either pay on day 10 and take the discount, financing the payment with the bank loan for 30 days, or pay on day 40. Using the simple annualised formula, which choice is better and why?

Take the discount. Forgoing 2/10, net 40 costs 2/98 multiplied by 360/30, about 24.49% a year, which is higher than the 14% bank loan. Borrowing from the bank to pay on day 10 is therefore the cheaper source of finance.

  1. APay on day 40, since the cost of forgoing the discount is 24.49%, which exceeds 14%
  2. BTake the discount, since forgoing it costs about 24.49%, which exceeds the 14% bank rateCorrect
  3. CPay on day 40, since 14% is below 24.49%
  4. DTake the discount, since the cost of forgoing it is 2%

Explanation

Cost of forgoing = 2/98 x 360/30 = 24.49%. Since bank finance costs 14%, it is cheaper to borrow and take the discount. Options 0 and 2 reach the wrong decision by treating 24.49% as a benefit; the last uses the unannualised 2%.

Did you get it right without looking?

One question tells you little. A timed set on Management of Payables (Creditors) shows your real accuracy, how long you take and where you lose marks.

Practise Management of Payables (Creditors)Free diagnostic mock

More Management of Payables (Creditors) questions