CA Intermediate · Financial Management and Strategic Management · Financing of Working Capital
Mehta Ltd. buys goods on terms 2/10 net 40. It decides to forgo the cash discount and pay on the last day. Using a 360-day year and the simple approximation formula, the annualised cost of forgoing the discount is closest to:
The annualised cost is about 24.49%. It is calculated as 2/98 multiplied by 360/30, because the firm gives up a 2% discount to extend payment by 30 days beyond the discount period. Using 100 as the denominator understates the cost.
- A18.37%
- B24.49%Correct
- C19.00%
- D14.69%
Explanation
Cost = [2/(100-2)] × [360/(40-10)] = 0.020408 × 12 = 24.49%. Using 2/100 instead of 2/98 gives 24%. Using 365 days or the wrong credit period would also give other values such as 18.37% (from 30-day-gap errors with 90 days).
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