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- This topic has 3 replies, 2 voices, and was last updated 1 year ago by John Moffat.

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- August 26, 2022 at 3:41 pm #664334
Hello sir, I have done this question in two ways. Please guide me which one is correct.

Product Q

The annual demand for Product Q is 456,000 units per year and Plot Co buys in this product at $1 per unit on 60 days credit. The supplier has offered an early settlement discount of 1% for settlement of invoices within 30 days

Plot finances working capital with short term finance for 5% per year. Assume 365 days.(b) Calculate the net value in dollars to Piot Co of accepting the early settlement discount for Product Q.

Solution 1: Assuming the rate as deposit rate (5%). We will invest the amount till the payment date (30 days more than discount repayment day).

If Accept Discount

Outflow= 456000*0.99=451440

Interest Income = 0

Total Costs = 451440If reject discount

Outflow = 456000

Interest income= 456000*5%*30/365= 1855

Total Costs = 454126

Net Saving if accepted Discount= 2686Solution 2: Assuming the rate as borrowing rate (5%). We borrow more finance to entertain the days we paid early (30 days earlier the credit term limit).

If Accept Discount

Outflow= 456000*0.99=451440

Interest Expense = 1855

Total Costs = 453295If reject discount

Outflow = 456000

Interest expense=0

Total Costs = 456000

Net Saving if accepted Discount= 2705Please help.

August 26, 2022 at 5:55 pm #664354Surely you have an answer in the same book in which you found the question (otherwise why are you attempting it? 🙂 ).

Although both of your approaches would probably be given most of the marks if it were in Section C of the exam (and if it were in Section A then it would be asked to the nearest $100 and so again you would get the marks).

However neither way is strictly correct. You need to calculate the current average payables and the new average payables (if they take the discount) and apply 5% interest to the difference and then compare this with the amount of the discount.

I explain all of this in my free lectures on the management of receivables!!!

August 26, 2022 at 7:56 pm #664367Oh! Thank you sir.

August 27, 2022 at 10:07 am #664401You are welcome.

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