ICANBusiness, Management and FinanceWorking Capital Management2025

Lagos Retail Plc is evaluating an early settlement discount of 2/10 net 60 offered by its supplier. The company's cost of short-term borrowing is 24% per annum. Should the company take the discount? (Assume a 365-day year.)

ANo, because the annualised cost of the discount at approximately 14.9% is less than the borrowing cost.
BYes, because the annualised cost of forgoing the discount at approximately 14.9% is less than the 24% borrowing cost.
CYes, because the annualised cost of forgoing the discount at approximately 14.9% exceeds the 24% borrowing cost.
DNo, because the annualised cost of forgoing the discount at approximately 29.8% exceeds the 24% borrowing cost.CORRECT
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Why the answer is D, and why the others tempt you.
The annualised cost of forgoing the discount = [Discount% ÷ (100 − Discount%)] × [365 ÷ (Credit period − Discount period)] = [2 ÷ 98] × [365 ÷ 50] = 0.02041 × 7.30 = 14.9%. Since 14.9% is less than 24%, the company should take the discount. However, using the simpler formula: (2/98) × (365/50) ≈ 14.9%. Because 14.9% < 24%, it is cheaper to borrow and take the discount. The correct answer is B: Yes, because forgoing the discount costs ~14.9% which is less than borrowing at 24%, so taking the discount is beneficial.
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