WORKING CAPITAL DICOUNT OFFER CONFUSION

There have benn the same type of question on june 2011 and december 2013 based on the working capital for accepting or rejecting discounts offered by suppliers, the exam solutions for june 2011 does not consider discount in computation of trade payables while the later considers discount, which approach was corre Thursday 9 June 2011 - trade payables after discount does not consider discount Annual demand is 120,000 components. The current terms are payment in full within 90 days, which ZPS Co meets, and the cost per component is $7·50----The supplier has offered either a discount of 0·5% for payment in full within 30 days----Assume that there are 365 days in the year and that ZPS Co can borrow short-term at 4·5% per year Early settlement discount Annual cost of components = 120,000 x 7·50 = $900,000 per year Value of discount offered = 900,000 x 0·005 = $4,500 Current level of payables = 900,000 x 90/365 = $221,918 Revised level of payables = 900,000 x 30/365 = $73,973 Reduction in payables = 221,918 – 73,973 = $147,945 Increase in financing cost by taking discount = 147,945 x 0·045 = $6,657 Net value of offer of discount $4500 - $6657 = -$2,157 Friday 6 December 2013 - trade payables after discount considers discount 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 Co finances working capital with short-term finance costing 5% per year. Assume that there are 365 days in each year. Product Q trade payables at end of year = 456,000 x 1 x 60/365 = $74,959 Product Q trade payables after discount = 456,000 x 1 x 0·99 x 30/365 = $37,105 Decrease in Product Q trade payables = 74,959 – 37,105 = $37,854 Increase in financing cost = 37,854 x 0·05 = $1,893 Value of discount = 456,000 x 0·01 = $4,560 Net value of offer of discount = 4,560 – 1,893 = $2,667