Justso Ltd buys on terms 1.5/10, net 30 days. It does not take discounts, but it
ID: 2733920 • Letter: J
Question
Justso Ltd buys on terms 1.5/10, net 30 days. It does not take discounts, but it typically pays 20 days after the invoice date, instead of waiting until Day 30. Justso can borrow from the bank at a rate of 18% per annum.
Required:
(a) If Justso is not taking discounts and is paying on Day 20, what is the effective annual cost of the firm’s current practice, using a 360-day year?
(b) Please advise Justso Ltd on its cheapest course of action if the firm’s suppliers do not take action on outstanding accounts unless they remain unpaid 80 days after the date of the invoice. Please back your advice up with appropriate calculations.
(c) Please advise Justso Ltd on its cheapest course of action if the firm’s suppliers take action on outstanding accounts when they remain unpaid at the start of the 31st day after the date of the invoice. Please back your advice up with appropriate calculations.
Explanation / Answer
a. Cost of credit = Discount %/(1-Discount %) x (360/(Full allowed payment days - Discount days))
= 1.50(1-0.015) x (360/(30-10))
= 26.595%
b. If the firm’s suppliers do not take action on outstanding accounts unless they remain unpaid 80 days after the date of the invoice, then he can delay in the payment of outstanding amount till it does not spoil its credit worthiness. It can effectively deploy the amount to earn an interest income of 18% for those many days.
c. If the firm’s suppliers take action on outstanding accounts when they remain unpaid at the start of the 31st day after the date of the invoice, then he should maximum pay it till that time. For the remaining period, he could earn interest income @ 18% for the aforesaid period.
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