You face supplier offer terms of 1.5/10, net 40 with a late payment fee of 1.5%

Question

You face supplier offer terms of 1.5/10, net 40 with a late payment fee of 1.5% per month. A competing supplier offers terms of 2.5/5, net 60 with no stated late payment fee. Your annual borrowing rate is 18%. Assume a 365-day year and Sales per period of $40,000.

What cash (lower cost) benefit do you derive if you shift to the competing offer and you use the full period within which to pay.

If you do not take the discount, what are you paying for the current supplier 30-day financing period (difference between the 40 day term and the 10 day discount period)?

If you do not take the discount from the new supplier, what are you paying for the 55 day financed period?

Explanation / Answer

Discount Percent/(100 - Discount percent )X 365/(Days Credit is outstanding -Discount period) = Cost of Not Taking the Discount

For existing offer :

(1.5/(100-1.5))*365/(40-10) = 18.527%

For competing offer:

(2.5/(100-2.5))*365/(60-5) = 17.01%

If you do not take the discount, what are you paying for the current supplier 30-day financing period (difference between the 40 day term and the 10 day discount period) : Cost of not taking discount for existing offer * sales per period

= 40000 * 18.527%

= $7,410.8

If you do not take the discount from the new supplier, what are you paying for the 55 day financed period:

Cost of not taking discount for existing offer * sales per period

= 40000 * 17.01%

= $ 6804

What cash (lower cost) benefit do you derive if you shift to the competing offer and you use the full period within which to pay. = $7,410.8 - $ 6804 = $606.8

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