Working Capital

Hello John

Jeeps Co is concerned about its cash position and has taken to delaying payments to some
suppliers in order to ease that problem. Each month the purchase ledger department splits
the total value of invoices for that month into three categories, A, B and C depending on
their importance.
Category A invoices, amounting to $2,000,000, are urgent and paid after 30 days
Category B invoices, amounting to $3,000,000, are less urgent and paid after 60 days; and
Category C invoices, amounting to $4,000,000, are least urgent and paid after 90 days.
Several suppliers have reacted to this by offering Jeeps Co a 2% cash discount if the
accounts are settled within 15 days.

Jeeps Co’s cost of capital is 12% per annum.
Assume that there are 30 days in a month and that purchases accrue evenly over the year.
(a) Jeeps Co is considering the advantage of the early settlement discount from those it
currently pays after:
1 60 days
2 90 days
From which payables should Jeeps take the 2% cash discount?
A 1 only
B Both 1 and 2
C 2 only
D Neither 1 nor 2

1. My sole issue with this question is that I’ve calculate the “old average payables” and the new one and compare those two figures. What’s wrong with my approach?

2. I believe that my approach is not correct as in the answer, the formula to calculate the cost of discount was used.

Thanks