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CS Professional · Strategic Management and Corporate Finance · Sources of Corporate Funding

Supplier offers Mehta Traders terms of '2/10, net 30' on invoices. Using the simple approximation formula (discount/(100 - discount)) x (360/(credit period - discount period)), what is the approximate annual cost of forgoing the cash discount?

The annual cost of forgoing the discount is about 36.73%. The discount of 2 on an effective payment of 98 is 2.04% per period, and since the extra credit is only 20 days, it repeats 360/20 = 18 times a year, giving 36.73%.

  1. A24.00%
  2. B36.73%Correct
  3. C24.49%
  4. D2.04%

Explanation

Cost = (2/98) x (360/(30-10)) = 0.020408 x 18 = 0.3673, i.e. 36.73%. Option 24.49% wrongly uses 360/30 = 12 periods instead of 18, giving 0.020408 x 12. Option 24.00% uses 2 x 12 with the wrong base and period. Option 2.04% is the per-period cost only.

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