Thank you for the wonderful lecture. Just wanted to check my understanding of the logic and terminology here, for the question in Example 1, is it correct to say that we are comparing between the Compound discount rate over a year (or per annum) and the simple interest rate from overdraft per annum?

Hi Mr Moffat. I hope you are well. in the second example that you showed i entered 1/99 on my calculator but it is giving me 0.01. How do i get the same figure as you got?

Maybe you have set your calculator to round to 2 decimal places, but 1/99 is certainly equal to 0.010101 (and not 0.01). You are going to have to look at the instruction manual that came with your calculator.

Yes, Sir. But when considering whether to offer the discount, should we take T/R days into account ? The 27.75% is only used for one month while the 20% is used for 3 months.

Sir, when i caculated the net cost in Example 1, i got two outcomes. One was (3/12*12*20%-1/12*12*27.75%)-4%*12m= -157,500 The other one was 60/365*12m*20%-4%*12m= -85,479 I wondered which one was correct.

Sir. Why don’t we use like: 4.167%*6 because 4.167% in the example is equal to 2 months? When I multiple like that, it will equally to 12 months . Is there any misunderstanding in here 馃檨

Yes, Sir. But why we cannot use the formula like in my examples. Is it because normally or in reality, people usually use compound interest instead of using simple interest, right Sir?

It is not a question as to what anyone might do in reality, it is calculating what the true interest cost per year is (which is what matters for the company).

Sir, I couldn’t understand the comparison of the Effective % cost with the overdraft interest of 20%. How does that tell us whether we should offer the discount or not?

Getting money early means we can reduce our overdraft and save the overdraft interest. However giving the discount is costing money even though it saves interest.

Hello, I am a bit confused her with the first example. From what I know, effective interest rate (R)= [(1+ i/n)^n] -1 My question is why didn’t you divide 0.04167 by 6 in the bracket? Any reason for that? Here is what i mean R= [(1+0.04167/6)^6] -1

The interest of 4.167% over 2 months. There are 6 periods of 2 months in a year and so if it was not for the fact that the interest was compounded, then the yearly interest would be 6 x 4.167%. Because it is compounded it is as I show in the lecture: (1.04167^6) – 1.

If you are still unsure about compounding then do watch the Paper MA lectures on interest, because this is revision from Paper MA (was F3).

I agree with your approach and it makes sense, (I have watched the lecture from MA). But why than your formula reveals the different results comparing to usual EAR formula: (R)= [(1+ i/n)^n] -1 ? This formula is used everywhere, even in Excel by using the internal formula “Effect” for EAR I got 25,44% instead of your’s 27.7559%. In Excel I used: =(EFFECT(0.04167,6)*6+1)*100 (for mine calculations with EAR formula) and =100*POWER(1.04167,6) – for yours.

thank you

joelsasisays

As per my understanding the formula is correct, but 4.167% over two months only not for per annum, therefore there is no need to divide by n as it is not given as annual interest rate.is this make sense?

we added 1 to the yearly rate in example 1 to get 1.04167 thats fine, but in the next question the yearly rate is 1.0101, when we add 1 to it it should be 2.0101 but you didnt add 1, may i ask why

If, for example, the monthly percentage was 1%, then adding on 1% each month is the same as multiplying by 1.01 each month – try it yourself with some made up numbers.

If you are still unsure that watch the Paper MA (was F2) lectures on interest.

You could use any figure, but because they are %’s it is easiest to use $100. For every $100 that they invoice, $4 is discount. Use X’s if you prefer!!

ty0311 says

Dear Sir,

Thank you for the wonderful lecture. Just wanted to check my understanding of the logic and terminology here, for the question in Example 1, is it correct to say that we are comparing between the Compound discount rate over a year (or per annum) and the simple interest rate from overdraft per annum?

Thanks in advance for your feedback.

Regards,

Tim

John Moffat says

Not really. We compounded the monthly cost of the discount to get the equivalent annual rate so as to compare with the overdraft annual rate.

(I wouldn’t really worry about the terminology here anyway for Paper FM)

JojoBeat says

Hi sir, does the effective cost p.a. mean the cost of the discount + interest cost of reduced overdraft together?

John Moffat says

No it doesn’t. It is the effective interest cost of offering the discount which we can then compare with the overdraft interest rate.

JojoBeat says

So if the question asked (in absolute terms) should we offer the discount, we would take the 20% x old receivables VS 27.76% x new receivables?

KGBEAST says

Mr. Moffat, why did you use TWO months not THREE months since it was THREE months given in the question??????

KGBEAST says

I’m sorry, I just figured out right now and unfortunately I can’t delete my comment, my apologies….

John Moffat says

No problem 馃檪

John Moffat says

The period is reduced by 2 months – from 3 months down to 1 month.

anisha17 says

Hi Mr Moffat. I hope you are well. in the second example that you showed i entered 1/99 on my calculator but it is giving me 0.01. How do i get the same figure as you got?

John Moffat says

Maybe you have set your calculator to round to 2 decimal places, but 1/99 is certainly equal to 0.010101 (and not 0.01).

You are going to have to look at the instruction manual that came with your calculator.

Jacqueline.S says

Sir, i don’t understand the comparision without mutiplying the effective cost by time factor.

e.g. 27.75%>20% instead of 1/12* 27.75% < 3/12*20%

John Moffat says

We are comparing the equivalent annual % cost of the discount with the annual % cost of the overdraft.

Jacqueline.S says

Yes, Sir. But when considering whether to offer the discount, should we take T/R days into account ? The 27.75% is only used for one month while the 20% is used for 3 months.

John Moffat says

No – they are both being expressed as yearly costs.

Jacqueline.S says

Thank you Sir.

John Moffat says

You are welcome 馃檪

Jacqueline.S says

Sir, when i caculated the net cost in Example 1, i got two outcomes.

One was (3/12*12*20%-1/12*12*27.75%)-4%*12m= -157,500

The other one was 60/365*12m*20%-4%*12m= -85,479

I wondered which one was correct.

james11 says

Sir. Why don’t we use like: 4.167%*6 because 4.167% in the example is equal to 2 months? When I multiple like that, it will equally to 12 months . Is there any misunderstanding in here 馃檨

John Moffat says

It is compound interest. Check back to the Paper MA (was F2) lectures if you have forgotten.

james11 says

Yes, Sir. But why we cannot use the formula like in my examples. Is it because normally or in reality, people usually use compound interest instead of using simple interest, right Sir?

John Moffat says

It is not a question as to what anyone might do in reality, it is calculating what the true interest cost per year is (which is what matters for the company).

james11 says

Thank you Sir.

John Moffat says

You are welcome 馃檪

Samuel says

Yet again, your explanations switching lightbulbs in my head. Thank you so much, Mr Moffat, for your concise explanations.

Vjhajharia says

Sir, I couldn’t understand the comparison of the Effective % cost with the overdraft interest of 20%. How does that tell us whether we should offer the discount or not?

John Moffat says

Getting money early means we can reduce our overdraft and save the overdraft interest. However giving the discount is costing money even though it saves interest.

Vjhajharia says

Okay. got it .Thanks 馃檪

John Moffat says

You are welcome 馃檪

florryb says

For example 2. How did we arrive at 10 days and 25 days. it’s nowhere in the question

praveen98 says

Its just his question not there in notes.

florryb says

For example 2, was 25 days and 10 days assumed. It’s nowhere in the question

asher2019 says

Thanks Mr Mofatt for this lecture. Your explanation is always in place.

afuakay says

Hello,

I am a bit confused her with the first example.

From what I know, effective interest rate (R)= [(1+ i/n)^n] -1

My question is why didn’t you divide 0.04167 by 6 in the bracket? Any reason for that?

Here is what i mean

R= [(1+0.04167/6)^6] -1

John Moffat says

Why would be divide by 6??

The interest of 4.167% over 2 months. There are 6 periods of 2 months in a year and so if it was not for the fact that the interest was compounded, then the yearly interest would be

6 x 4.167%. Because it is compounded it is as I show in the lecture: (1.04167^6) – 1.

If you are still unsure about compounding then do watch the Paper MA lectures on interest, because this is revision from Paper MA (was F3).

avenu507 says

I agree with your approach and it makes sense, (I have watched the lecture from MA).

But why than your formula reveals the different results comparing to usual EAR formula: (R)= [(1+ i/n)^n] -1 ?

This formula is used everywhere, even in Excel by using the internal formula “Effect” for EAR I got 25,44% instead of your’s 27.7559%.

In Excel I used: =(EFFECT(0.04167,6)*6+1)*100 (for mine calculations with EAR formula) and =100*POWER(1.04167,6) – for yours.

thank you

joelsasi says

As per my understanding the formula is correct, but 4.167% over two months only not for per annum, therefore there is no need to divide by n as it is not given as annual interest rate.is this make sense?

unfazed says

we added 1 to the yearly rate in example 1 to get 1.04167 thats fine, but in the next question the yearly rate is 1.0101, when we add 1 to it it should be 2.0101 but you didnt add 1, may i ask why

John Moffat says

If, for example, the monthly percentage was 1%, then adding on 1% each month is the same as multiplying by 1.01 each month – try it yourself with some made up numbers.

If you are still unsure that watch the Paper MA (was F2) lectures on interest.

cm1985 says

Kindly help me to understand where $100 is coming from.

John Moffat says

You could use any figure, but because they are %’s it is easiest to use $100. For every $100 that they invoice, $4 is discount.

Use X’s if you prefer!!

cm1985 says

Thank you very much.

faizankhan23 says

Why do we add 1 to the percentage while calculating the annual cost