Assume the proceeds from the loan with the compensating balance requirement
will be used to take cash discounts. Disregard part b about installment payments
and use the loan cost from part a.
If the terms of the cash discount are 1.5/10, net 50, should the firm borrow the funds
to take the discount?
To determine whether the firm should borrow the funds to take the cash discount, we need to consider the cost of the loan compared to the amount saved by taking the discount.
To calculate the cost of the loan, we first need to know the interest rate and the loan amount. However, since you mentioned that part b about installment payments should be disregarded, we do not have the interest rate for the loan.
Therefore, we cannot directly determine the cost of the loan. However, we can still evaluate the decision based on the cash discount terms.
The cash discount terms 1.5/10, net 50 mean that if the firm pays within 10 days, they can take a 1.5% discount. Otherwise, the full payment is due within 50 days.
To decide whether it is advantageous to borrow the funds, we need to compare the savings from the discount to the potential cost of the loan.
To calculate the savings from taking the cash discount, we multiply the discount percentage (1.5%) by the amount of the purchase. Let's assume the purchase amount is $10,000. The savings from the discount would be:
$10,000 x 1.5% = $150
Now, considering the loan cost, if the interest rate is lower than the savings of $150, it would be financially beneficial to borrow the funds and take the cash discount. If the interest rate is higher than $150, it would not be advantageous to borrow the funds.
Since we don't have the interest rate for the loan, we cannot determine the exact cost of the loan. Hence, we cannot give a definitive answer as to whether the firm should borrow the funds to take the discount based on the given information.