WORKING CAPITAL DICOUNT OFFER CONFUSION

There have benn the same type of question on june 2011 and december 2013 based on the working capital for accepting or rejecting discounts offered by suppliers, the exam solutions for june 2011 does not consider discount in computation of trade payables while the later considers discount, which approach was corre

Thursday 9 June 2011 – trade payables after discount does not consider discount

Annual demand is 120,000 components. The current terms are payment in full within 90 days, which ZPS Co meets, and the cost per component is $7·50—-The supplier has offered either a discount of 0·5% for payment in full within 30 days—-Assume that there are 365 days in the year and that ZPS Co can borrow short-term at 4·5% per year

Early settlement discount
Annual cost of components = 120,000 x 7·50 = $900,000 per year
Value of discount offered = 900,000 x 0·005 = $4,500

Current level of payables = 900,000 x 90/365 = $221,918
Revised level of payables = 900,000 x 30/365 = $73,973
Reduction in payables = 221,918 – 73,973 = $147,945
Increase in financing cost by taking discount = 147,945 x 0·045 = $6,657

Net value of offer of discount $4500 – $6657 = -$2,157

Friday 6 December 2013 – trade payables after discount considers discount

The annual demand for Product Q is 456,000 units per year and Plot Co buys in this product at $1 per unit on 60 days credit. The supplier has offered an early settlement discount of 1% for settlement of invoices within 30 days—-Plot Co finances working capital with short-term finance costing 5% per year. Assume that there are 365 days in each year.

Product Q trade payables at end of year = 456,000 x 1 x 60/365 = $74,959
Product Q trade payables after discount = 456,000 x 1 x 0·99 x 30/365 = $37,105
Decrease in Product Q trade payables = 74,959 – 37,105 = $37,854
Increase in financing cost = 37,854 x 0·05 = $1,893
Value of discount = 456,000 x 0·01 = $4,560
Net value of offer of discount = 4,560 – 1,893 = $2,667