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Formula in Study Text:
Annual cost of discount = (1 + discount/amount left to pay) no. of periods -1A company is offering a cash discount of 2.5% to receivables if they agree to pay debts within 1 month. The usual credit period taken is 3 months.
What is the effective annualised cost of offering the discount and should it be offered, if the bank would loan the company at 18% p.a.?
My workings:
I assumed an invoice of $100.(1 + 2.50/97.50) to the power of 6 (12/2) – 1= 16.405% and I rounded it to 16.41%
Yes, it wise to offer the settlement discount.The answer in the Study Text was 16.38%.
Where did I go wrong?
Thanks! 🙂
Your answer is correct!
Don’t worry about it for the exam – they will ask it to the nearest % or to the nearest 0.1% to avoid problems with rounding differences!
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