MenuItem9:(Topic 9)Short-term debt
Question 1: Sparko Electrical Services purchases electrical cable, switches and fittings on credit.
The company receives an invoice from the supplier that states ‘2/10, n/30’. What does this note on
the invoice mean?
A: the date is 2 October and the company has 30 days to pay in full
B*: if payment is made in ten days a 2 per cent discount applies; otherwise, full payment is due in
30 days
C: this is the second time in ten months that the company has been 30 days late
D: if payment is made in two days a 10 per cent discount applies; otherwise, full payment is due in
30 days
Feedback: The note means that if Sparko pays the account within 10 days there is a 2 per cent
discount; otherwise, the full amount shown on the invoice is payable within 30 days.
MORE:
Financial Institutions, Instruments and Markets 5/e
, p. 358.
The terms of trade credit are usually specified on the invoice attached to the goods. The
invoice
typically contains information describing the goods supplied, the price, the total
amount due and the terms of payment. If the terms include provisions other than cash on
delivery, the purchaser is effectively being granted a short-term loan. Suppliers who offer
trade credit may encourage early payment by providing a discount for early payment of the
account. For example, the terms may be ‘2/10, n/30’. The ‘2/10’ indicates that if payment
is made within ten days the invoice price will be discounted by 2 per cent; ‘n/30’, or ‘net
30 days’, signifies that if payment has not been made within ten days the full invoice price
is payable within thirty days.
Question 2: DLK Plumbing Contractors has received an invoice for goods purchased on credit. The
invoice states ‘2/10, n/60’. If DLK pays the account within ten days and receives the discount, what
annual rate of return does it earn by doing so?
A: 17.3 per cent
B*: 14.9 per cent
C: 22.36 per cent
D: 12.41 per cent
Feedback: If DLK pays early and receives the discount, it earns a return of 2 per cent over fifty
days. The corresponding annual rate of return is:
(2/98)
×
(365/50) = 0.14897 or 14.9 per cent.
MORE:
Financial Institutions, Instruments and Markets 5/e
, p. 358.
If a credit period and early settlement period with discount are provided, the purchaser
has a choice: either pay early and receive the discount, or pay in full by the later specified
date and obtain a longer period of credit. The choice should be determined by calculating
the opportunity cost of the discount versus the benefit of the extended credit period. If the
offer of the discount is taken, the purchaser will need to have the funds available to pay for
the goods at that date. The purchaser needs to consider the opportunity cost associated with
two alternative situations: the after-tax cost of other available types of short-term credit,
and the return that could be obtained from investing surplus cash during that period. For
MaxMark t/a
Financial Institutions, Instruments and Markets 5e
by Viney
1