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CA Intermediate · Financial Management and Strategic Management · Financing of Working Capital

Sharma Traders buys goods on terms 2/10 net 40. It forgoes the cash discount and pays on the 40th day. Using a 360-day year and the simple (non-compounded) formula, what is the approximate annual cost of forgoing the discount?

The approximate annual cost is 24.49%. The discount of 2 on a net payment of 98 is 2.04% for stretching payment by 30 days (40 minus 10). Annualising with 360/30 equals 12 periods gives 2.04% times 12, which is 24.49%.

  1. A24.49%Correct
  2. B18.00%
  3. C12.24%
  4. D36.73%

Explanation

Cost = [Discount/(100 - Discount)] x [360/(Credit period - Discount period)] = (2/98) x (360/30) = 0.020408 x 12 = 24.49%. Using 360/40 would give 18.37%, an incorrect base for the days. Using 2/100 instead of 2/98 would give 24.00%, which is also wrong.

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