In part A) can we calculate the effective cost of refusing the discount and compare it with the cost of financing working capital? I calculated the effective cost of refusing the discount to be 6.2% which is greater than the cost of financing working capital and therefore we should accept the discount from the supplier. Please let me know if this approach can be used to solve this question. Thanks

On part A I assumed you would realise the new overdraft cost as 30/360 x 1,492,500 = 124,375 x 4% = 4975. Therefore the saving on overdraft would be old overdraft cost of 10,000 minus 4975 = 5025.

I know from the answer this is wrong but I am not sure why? After you take the early settlement discount the amount you are paying is now less.

What you have done is fine and as I say in the free lecture the examiner always accepts either subtracting the discount or not subtracting it (even through the final answer is slightly different).

msraja90 says

Sir,

In part A) can we calculate the effective cost of refusing the discount and compare it with the cost of financing working capital? I calculated the effective cost of refusing the discount to be 6.2% which is greater than the cost of financing working capital and therefore we should accept the discount from the supplier. Please let me know if this approach can be used to solve this question. Thanks

John Moffat says

No, you should not use this approach because there is also the extra admin cost of 500 per year to be considered.

Have you watched my free lectures on the management of receivables and payables?

msraja90 says

Yes Sir I saw that and I have understood why this method cannot be used. Thank you Sir, your lecturers are very helpful.

John Moffat says

You are welcome, and thank you for the comment 馃檪

Himesh says

Hi John

On part A I assumed you would realise the new overdraft cost as 30/360 x 1,492,500 = 124,375 x 4% = 4975. Therefore the saving on overdraft would be old overdraft cost of 10,000 minus 4975 = 5025.

I know from the answer this is wrong but I am not sure why? After you take the early settlement discount the amount you are paying is now less.

Please explain where my thinking is wrong?

Thanks

John Moffat says

What you have done is fine and as I say in the free lecture the examiner always accepts either subtracting the discount or not subtracting it (even through the final answer is slightly different).