AJAX Corp. needs $100,000 for the next 30 days. The company has $100,000 in cash

Question

AJAX Corp. needs $100,000 for the next 30 days. The company has $100,000 in cash it was expecting to use to pay off accounts payable in order to take advantage of the 2/10 net 40 credit terms. Another source of financing is a short-term bank loan with an interest rate of 20%. Would you recommend AJAX borrow the $100,000 it needs from the bank and use the cash it already has to pay its accounts payable and take the cash discount, or would you recommend the company forgo the cash discount and use the $100,000 it has for its financing needs?

Explanation / Answer

Discout received if amount paid to creditors = 100000*2% i.e 2000

Interest cost if financed from bank = 100000*20%*30/365 i.e 1644

Therefore it is beneficiary to pay to the creditors and finance the asset by taking loan from the bank as there is an incremental benefit of ( 2000-1644) i.e 356

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