Question

(8 pts) 5. Riley Corp. purchases $5,000,000 worth of materials each month on credit terms of 3/12, n/40. Riley always pays on day 40, never taking the discount. Riley does this because they do not collect from customers until the end of the month. Riley could borrow money from a bank at a rate of 15%. Explain through computations why this might not be a good strategy. Show computations.

Answer 1

It is a good strategy because Riley Corp. could gain from taking the loan.
Interest on loan for 40 days
Loan Amount	5,000,000
Interest rate	15%
Number of days	40
Interest paid	82,192
(5,000,000 x 15% x 40/365)
Discount availed if loan was taken
Purchases	5,000,000
Terms	3/12 net 40
Discount % if paid early	3%
Discount received	150,000
Net gain or loss from taking the loan
Discount received	150,000
Interest paid	82,192
Net gain from taking the loan	67,808
(150,000 - 82,192)
Note: If the loan is availed on the 12th day (last day of availing discount),
then the interest paid will be much lesser and the gain will increase.