Global Logistics purchased a new machine on October 20th, 2014 for $1,

Global Logistics purchased a new machine on October 20th, 2014 for $1,000,000 on credit. The supplier has offered A&A terms of 2/10, net 45. The current interest rate the bank is offering is 16 percent.

(a) Compute the cost of giving up cash discount.
(b) Should the firm take or give up the cash discount?
(c) What is the effective rate of interest if the firm decides to take the cash discount by borrowing money on a discount basis?

ANSWER

(a) Cost of foregoing cash discount × = 21%
(b) Since the cost of foregoing cash discount is greater than the bank’s interest rate, the firm should take cash discount.
(c) Interest = 1,000,000 × 0.16 × (35/360 ) = $15,555.56
Effective rate = × = 16.48%