Question

3. e-Five Corp. does not presently offer a cash discount and sells on net 30 terms. However, the firm would like to offer a cash discount for payments made on day 10 to retain its customers as many of the firm's competitors have begun to sell on terms of 1.5/10, net 30. Assuming the firm's cost of funds is 17%, what is the maximum cash discount the firm can offer? What is the optimal discount? (Assume no change in sales)

Answer 1

Presently the firm does not provide any discounts for early payment and net payment is received in 30 days. Firm is proposing to introdue discount terms. i.e X% / 10 net 30. The customers would get X% discount if payment made in 10 days otherwise they need to pay in net 30 days. Hence in this concept we will receive the payments 20 days earlier. Effectively we will be saving cost for 20 days. Lets assume Sales as 100 and year days as 360

InterestCost saved on 20 days = 100 Sales * 17% * 20 / 360 = 0.94%

Hence, the firm may offer 0.94% of discount for the payment to be made in net 10 days which is the optimal discount.