CMA practice question 9 of 35

An organization would usually offer credit terms of 2/101 net 30 when

Full set: 1,331 questions

Answer options

A: The organization can borrow funds at a rate exceeding the annual interest cost.

B: The organization can borrow funds at a rate less than the annual interest cost.

C: The cost of capital approaches the prime rate.

D: Most competitors are offering the same terms, and the organization has a shortage of cash. Correct answer

Correct Answer:

D. Most competitors are offering the same terms, and the organization has a shortage of cash.

Explanation

A 2/10, net 30 discount costs the seller about 2 % to receive cash 20 days earlier, an effective annual rate of roughly 37 %. A firm normally adopts so costly a policy only when it urgently needs to accelerate cash collections and when competitors already extend similar terms, so refusing to match them would risk losing sales.

Why Incorrect

A. Borrowing costs above ~37 % are extraordinarily rare; the discount would usually be more expensive than bank credit.
B. If funds can be borrowed below 37 %, it is cheaper to finance receivables than to give a 2 % discount.
C. The prime rate is a benchmark for longer-term loans and does not drive day-to-day trade-credit decisions.

References

1. Ross

Westerfield & Jordan

Corporate Finance 12e

Ch.26

pp. 881-883.

2. Brigham & Ehrhardt

Financial Management 15e

Ch.16

pp. 603-604.

3. IMA CMA LOS 2023

Part 2-B3 (Credit and collections).

4. Ng

Smith & Smith (1999) Journal of Finance

54(2)

1109-1129

https://doi.org/10.1111/0022-1082.00442.

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