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getsetgo
getsetgo, MBA
Category: Homework
Satisfied Customers: 3486
Experience:  MBA from IIM Calcutta, Engineer, 8+ years of exp. at executive level
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When shouldnt a firm take advantage of the discount?

Resolved Question:

When shouldn’t a firm take advantage of the discount?
Submitted: 4 years ago.
Category: Homework
Expert:  getsetgo replied 4 years ago.
A customer should take advantage of cash discount if it has higher effective annual interest rate (EAR) than the rate customer pays to borrow money.

If customer can borrow money at a rate less than EAR, customer should avail the discount.
If cost of borrowing of customer is higher than EAR, customer should not take advantage of discount.
Customer: replied 4 years ago.

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?

 

Expert:  getsetgo replied 4 years ago.

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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Expert:  getsetgo replied 4 years ago.
THIS ANSWER IS LOCKED!

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