Chapter 8, Problem 1DQ

Under what circumstances would it be advisable to borrow money to take a cash discount? (LO8-1)

Summary Introduction

To explain: The circumstances that would be advisable to borrow money instead of taking a cash discount.

Introduction:

Cash discount:

When a buyer pays the amount owed by him to the seller before the scheduled date i.e. the date when the payment is supposed to be made. The seller sought to give an incentive to the buyer for making an early payment, this incentive is generally given in the form of a discount or reduction in the amount that the buyer is paying by a fixed percentage or a certain amount. This incentive is popularly known as cash discount.

Borrowed money:

It is an amount of money that one entity borrows from another entity or a financial institution. The borrower agrees to pay back the borrowed money to the lender by giving a pre-determined interest rate along with the principal amount after a certain time period. Sometimes, the lender asks for collateral from the borrower in the form of a security in case the borrower defaults.

Answer to Problem 1DQ

The circumstances that would enable the buyer to borrow money instead of a taking a cash discount will be when the interest amount would be less than the amount of cash discount.

Explanation of Solution

It will be advisable for the buyer to borrow money from a lender to repay his bill rather than taking a cash discount in a circumstance wherein the interest charged by the financial institution on the loan is less than the amount of cash discount that is getting offered to the buyer by the seller. For example, if missing a cash discount costs the buyer 25% of the total amount wherein, he’s available for cheaper loans; which would only cost him around 9 to 12%. He is better off going with the loans and save 15% rather than stumbling upon cash discounts.