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Hello,
Nesud Co has credit sales of $45 million per year and on average settles accounts with trade payables after 60 days. One of its suppliers has offered the company an early settlement discount of 0.5% for payment within 30 days. Administration costs will be increased by $500 per year if the early settlement discount is taken. Nesud Co buys components worth $1.5 million per year from this supplier. Nesud Co finances working capital from an overdraft costing 4% per year. Assume there are 360 days in a year.
I have difficulty understanding how the new level of trade payable is calculated for the purpose of finding the financing cost of payables. The answer is Trade payables after discount=1,5M*30/360=125.000. But if the company accepts the discount, its new level of purchases becomes =1.5M*(1-0,005)=1.492.500. Shouldn’t we calculate the new level of payables based on the new level of purchases?
As I explain in my free lectures on this, there are arguments for and against subtracted the 0.5%. The examiner is not consistent in his answers – sometimes he subtracts it and sometimes he does not, but he has made it clear that you would get full marks either way (even though obviously the final answer is slightly different).
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