Question

Your supplier from whom you have purchased materials on credit offers the following payment terms: pay the credit balance of $100,000 within 30 days after the delivery of the material; if you pay within 10 days of the delivery you would get a 1% discount (i.e., you pay only $99,000). When would you pay your supplier, if you can borrow, or lend, up to $100,000 to, or from, the bank at the annual interest rate of 5%?

Answer 1

It is financially beneficial to pay the supplier within 10 days to make use of the 1% discount, as the interest cost of borrowing the money is significantly lower than the discount gained.

Step-by-step explanation:

If you can borrow or lend money from the bank at an annual interest rate of 5%, it would be financially advantageous to pay the supplier within 10 days and avail the 1% discount. Paying $99,000 instead of $100,000 saves you $1,000 right away. If you were to borrow $100,000 from the bank to pay the supplier, the cost of the loan over 20 days (assuming you pay the supplier on the 10th day and repay the bank on the 30th day) would be much less than the $1,000 discount since the daily interest rate is approximately 0.0137% (which is 5% divided by 365 days). Over 20 days, this amounts to about $274 in interest (100,000 × 0.0137% × 20 days). Therefore, paying early and saving $1,000 is better than paying $274 in interest and losing out on the discount.