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6) A company has sales of 200M per year.
Currently on average customers take 40 days to pay.
The company is considering offering a discount of 1% for payment within 15 days and expects that 60% of the customers will take advantage of the discount.What is the Effective Annual Cost of offering the discount?
a) 15.80%
b) 9.22%
c)15.63%
d) 9.13%Thanks.
They get a discount if they pay 15 days earlier than normal.
The cost is 1/99 over 15 days.
Therefor over a year it will be
( (1 + 1/99) ^ (365/15) ) – 1John,
What’s the difference between this method and the method used in the open tuition notes?
I.e
1/99 x 365/15 = 25%The method in our lecture (you must not use the notes without the lectures) is only an approximate method, but the examiner has always accepted it.
Strictly you should do it the way I wrote in my previous reply.Hi John,
60%*15+40%*40 = 25 days,
therefore with discount, we will shorten receivable days by 40-25= 15 days.( (1 + 1/99) ^ (365/15) ) – 1 = 0.277
There is not one answer of 27.7%. Many thanks.
The correct answer is in my first answer on this page.
If we are calculating the effective annual cost then if it is less than the cost of overdraft interest it is worth offering the discount, and if it is more then it is not worth offering.
It is irrelevant how many customers actually take the discount – whatever we think might happen, it is not our decision.I do suggest that you watch my free lectures on this – it is mentioned in the lecture working through the first example of the relevant chapter of our free lecture note.
(Our lectures are a complete course for Paper F9 and cover everything needed to be able to pass the exam well)
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