Question

You purchased materials from a supplying company. You have purchased the Items on credit and the supplying company offers the following payment terms: pay the credit balance of $200,000 within 30 days after the delivery of the material; if you pay within 10 days of the delivery you would get a 1% discount

When would you pay the supplier, if you can borrow, or lend, up to $100,000 to, or from, the Bank at the annual interest rate of 5%? explain your answer showing your calculation.

Answer 1

It is financially better to pay the supplier within 10 days to receive the 1% discount on the $200,000 credit balance, as the discount amount of $2,000 exceeds the borrowing cost of approximately $27.40 for 20 days at an annual interest rate of 5% for half the balance.

Step-by-step explanation:

The question involves analyzing the financial decision of when to pay a supplier under given credit balance terms with an option of a discount versus the cost of borrowing money. If you pay within 10 days, you receive a 1% discount on a $200,000 credit balance. This discount amounts to $2,000. If you decide to pay between day 10 and day 30, you can borrow money from the bank at an annual interest rate of 5%, but you would forgo the discount.

Calculation of interest: Assuming you borrow $100,000 for 20 days (the difference between paying at day 10 or day 30), the daily interest rate would be (5% annual rate / 365) which is approximately 0.0137% per day. Thus, for 20 days, the interest would be about 0.0137% * 20 days * $100,000 = $27.40. Since the cost of borrowing for 20 days ($27.40) is significantly less than the discount offered for paying early ($2,000), it would be financially advantageous to pay within 10 days and take the discount, even if you need to borrow the money to do so.