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

Mehta Industries has annual purchases of Rs 36,00,000 on terms '1/15, net 45'. It is considering whether to take the discount by borrowing from a bank at 12% p.a. (360-day year). Which decision is correct?

Mehta should take the discount. Forgoing 1/15 net 45 costs (1/99) x (360/30) = 12.12% a year, which is more than the 12% bank borrowing rate, so borrowing to pay early on day 15 is slightly cheaper than using the supplier's credit.

  1. ATake the discount, because the cost of forgoing it is about 12.12% ... which is below bank rate
  2. BForgo the discount, because forgoing cost of about 12.12% exceeds nothing
  3. CTake the discount, because the cost of forgoing it is about 12.12% which exceeds the bank rate of 12%Correct
  4. DForgo the discount, because the cost of forgoing it is about 6.06% which is below the bank rate

Explanation

Cost of forgoing = (1/99) x (360/30) = 1.0101% x 12 = 12.12%. This is higher than the 12% borrowing rate, so it is cheaper to borrow and take the discount. Option 4 halves the cost by mistake, and option 1 misstates the comparison.

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