A firm is offered credit terms of 1/10 net 45 EOM by a major supplier. The firm has determined that it can stretch the credit period (net period only) by 25 days without damaging its credit standing with the supplier. Assuming the firm needs short-term financing and can borrow from the bank on a line of credit at an interest rate of 14 percent, the firm should ________.
A) give up the cash discount and finance the purchase with the line of credit
B) give up the cash discount and pay on the 70th day after the date of sale
C) take the cash discount and pay on the first day of the cash discount period
D) take the cash discount and finance the purchase with the line of credit, the cheaper source of funds

Question

Quizplus · Accepted Answer

The firm can stretch the credit period by 25 days without damaging its credit standing with the supplier. Thus, the new net credit period for the firm becomes 70 days (45 + 25). The firm should give up the cash discount and pay on the 70th day after the date of sale, as this would cost less than either taking the discount or financing the purchase with the line of credit.

If the firm takes the cash discount and pays on the first day of the cash discount period, it would have to pay within 10 days, reducing its net credit period to 35 days. This may not be feasible for the firm, as it needs short-term financing.

If the firm finances the purchase with the line of credit, it would have to pay interest at the rate of 14 percent. This would cost more than paying on the 70th day after the date of sale.

A Firm Is Offered Credit Terms of 1/10 Net 45