BORROWING TO TAKE ADVANTAGE OF CASH DISCOUNT.

ILLUSTRATION 1

Mr A bought some goods valued at $100,000 with a cash discount terms of 5/10, n/60.

What is the annualized cost of the credit if the cash discount is not taken?

Solution:

Cash discount not taken=5% x $100,000

=$5,000

Credit period =60-10 days =50 days

Annualized cost =

Discount Percent x 360

(100-Discount %) (Credit period)

=5%/95% x360/50

= 37.9%

ILLUSTRATION 2

On 20^th January 2006, Mr A bought some goods at $100,000 with cash discount term 3/10,n/30.

To pay the invoice on 30 th January, she borrowed the money for 20 days at 10% per annum simple interest.

How much did she save by borrowing to take advantage of the discount?

Solution:

Cash discount = 3% x $100,000 =$3,000

Principal borrowed =$100,000 -$3,000 =$97,000

Credit period = 30 days – 10 days =20 days

Simple interest calculation:

Principal x interest x time (Prt)

=$100,000 x 10% x 20/360

= $555.56

Net amount saved = Cash Discount – Interest

= $3,000 -$555.56

= $2,444.44