I am sorry but that answer is when you should take advantage of discount.
The question is: When shouldn't a firm take advantage of the discount?
A customer should take advantage of cash discount only if it has higher effective annual interest rate (EAR) than the rate customer pays to borrow money. If cost of borrowing of customer is higher than EAR, customer should not take advantage of discount.
Example: Let us assume that credit term is 2/10 net 45
Let customer buys merchandise of $500.
Customer will pay $500(1 - 2%) = $490 if paid in 10 days
Customer will pay $500 if paid in 45 days
Finding the implied interest rate when customers do not take the discount
Credit terms of 2/10 net 45 and $500 loan
$10 interest (.02*500)
Period rate = 10 / 490 = 2.0408%
Period = (45 – 10) = 35 days
365 / 35 = 10.4286 periods per year
EAR = (1.020408)^10.4286 – 1 = 23.45%
In this case, if cost of borrowing of customer is higher than 23.45%, customer should not take advantage of discount.
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