DISCOUNT RATE AND CASH DISCOUNT
2.1INTRODUCTION
In our daily life, we often hear the word “discount”. Many goods are sold at
discounted prices to attract the customers. In order to encourage an early payment before
the due date, the seller also often offers cash discount to their customers. In addition, the
discount rate is also used in calculating the interest of promissory notes or loans which is
withheld in advance. The interest which is withheld in advance makes the effective
interest rate imposed higher compared to the interest paid at the end of the period.
2.2DISCOUNT AND DISCOUNT RATE
In Chapter 1, we have discussed discount factor or discounted with the simple
interest, i.e. the process to calculate P with given S, r and t. The difference S – P or D is
called simple discount or bank discount at a specific interest rate. In this book, simple
discount or bank discount will simply be called discount.
Example 2.1
How much is the discount value of Rp. 8.000.000 during 9 month at interest rate of 10%
p.a.?
Answer:
S = Rp. 8.000.000
r = 10% = 0.1
9
t= = 0.75
12
S
P=
(1 + rt )
Rp.8.000.000
=
(1 + ( 0.1 × 0.75) )
= Rp. 7.441.860,47
D = S – P
= Rp. 8.000.000 Rp. 7.441.860,47
= Rp. 558.139,53
In the information given is the discount rate (d) instead of the interest rate (r), we should
use another equation which relates variables D (discount) and S (sum of the amount of
final nominal), d (discount rate) and t (time).
Discount (D) from the sum (S) during t years with the discount rate (d) is:
D = S d t (7)
Whereas,
P = S – D (8)
By substituting Equation (7) into Equation (8), we will get:
P = S – D
P = S – (S d t)
P = S (1 – d t) (9)
Based on the last equation, we can see that the interest, in this case the discount,
can be calculated from the final value (S) by using the discount rate instead of using the
interest rate. This treatment is frequently done especially for the short term loan. The
lender calculates the discount (D) from S or the amount that should be paid on the due
date by using the discount rate and not using the interest rate. Therefore, the term
discount is often called the interest which is withheld in advance.
The difference between the interest rate is only applicable for money market
securities and not for other securities (shares and bonds). For medium term or long term
(more than 1 year), the discount rate and the interest rate have the same meaning; thus,
there is only one equation for calculating the present value. In other words, the interest
rate is the discount rate and vice versa.
2.3THE MANIPULATION OF DISCOUNT EQUATION
From equation (9), we can also state S in terms of P, d and t, as follows:
P
S= (10)
1 − dt
This equation is frequently used to calculate the final value or the due date value from
loan in amount of P which has been received in advance.
Example 2.2.
Mr. Tri borrows Rp. 50.000.000 during 6 months from a bank that imposes a discount
rate of 12%. How much is the discount and the amount of money received by Mr. Tri?
Answer:
S = Rp. 50.000.000
d = 12%
6
t= = 0.5
12
D = s d t
= Rp. 50.000.000 × 12% × 0.5
= Rp. 3.000.000
Therefore, the amount of money received by Mr. Tri is
P = S – D
= Rp. 50.000.000 – Rp. 3.000.000
= Rp. 47.000.000
Example 2.3
Continuing the above example, how much is the loan which should be proposed by Mr.
Tri in order to receive money in amount of Rp. 50.000.000 in full?
Answer:
P = Rp. 50.000.000
d = 12%
t = 0.5
P
S=
1 − dt
Rp.50.000.000
S=
(1 − (12% × 0.5) )
= Rp. 53.191.489,36
In order to receive Rp. 50.000.000 in full, Mr.Tri should propose a loan in amount of Rp.
53.191.489,36.
Example 2.4.
Calculate the present value of Rp. 10.000.000 that will be due within one year by using:
a. Interest rate of 10%
b. Discount rate of 10%
Answer:
a. S = Rp. 10.000.000
r = 10% = 0.1
t = 1
S
P=
(1 + rt )
Rp.10.000.000
=
(1 + ( 0.1 ×1) )
= Rp. 9.090.909,09
b. S = Rp. 10.000.000
d = 10% = 0.1
t = 1
P = S (1 – dt)
= Rp. 10.000.000 ( 1 – (0.1 × 1))
= Rp. 9.000.000
Please note that between the above answer there is a difference in amount of Rp.
9.090.909,09. The use of discount rate always gives bigger profit for the lender (in this
case is the bank) compared to the use of interest rate of the same amount.
We can calculate the interest rate which is equivalent with a certain discount rate and vice
versa.
The discount rate (d) and the interest rate (r) is equivalent if both variables give the same
present value for the same S in the future.
By using Equation (6) and Equation (9), we can derive a new equation:
S
= S (1 − dt )
(1 + rt )
1
= 1 − dt
(1 + rt )
1
= 1 + rt
(1 − dt )
1
− 1 = rt
(1 − dt )
1 − (1 − dt )
= rt
(1 − dt )
dt
= rt
(1 − dt )
d
=r (11)
(1 − dt )
With the same way, we can also calculate the discount rate which is equivalent with a
certain interest rate, as follows:
S
= S (1 − dt )
(1 + rt )
1
= 1 − dt
(1 + rt )
1
1− = dt
(1 + rt )
(1 + rt ) − 1 = dt
(1 + rt )
r
=d (12)
(1 + rt )
Example 2.5.
If the discount rate of a bank is 9%, how much is the interest rate equivalent for t = 1?
Answer:
d
r=
1 − dt
9%
r= = 9.89%
1 − 9%(1)
Example 2.6.
If the interest rate of a bank is 10%, how much is the discount rate equivalent for period
of 6 months?
Answer:
r
d=
1 + rt
10%
d=
1 + 10%( 0.5)
d = 9.52%
2.4PROMISSORY NOTES
A promissory note is a written agreement of a debtor to settle to, or based on
instruction from, the creditor an amount of money with or without interest on a certain
date. Promissory note are often called Prenotes or Pnotes. Promissory notes with
interest are called interestbearing notes, whereas those without interest are called non
interest bearing notes. In accountancy, promissory notes are also called notes receivable
for the recipient and notes payable for the issuer.
Below is one simple example of an interestbearing note with nominal value of Rp.
100.000.000. The issuance date is 1 July 2006 and will be due within 60 days or on 31
August 2006 with 11% interest. The amount at the due date is Rp. 100.000.000 × (1 +
0.11) × (60/365) = Rp. 101.808.219,2.
Depok, 1 July 2006
Rp. 100.000.000 (one hundred million rupiahs)
Signature,
Achmad
A promissory note can be sold once or more than once before the due date. Each
buyer will calculate the discount from the delivery date until the due date by using its
discount rate. The amount due subtracted by the discount is the amount that will be
received by the seller.
Example 2.7.
If the above promissory note signed by Mr. Achmad is sold on 1 August 2006 by Mr.
Bachtiar to Bank AAA with a discount rate of 15%, calculate:
a. How much money that will be received by Mr. Bachtiar?
b. What is the interest rate that will be received by the bank from its investment in
the above promissory note if that promissory note is held until the due date?
c. What is the interest rate that will be received by Mr. Bachtiar when he sells it on 1
August 2006?
Answer:
a. Firstly, we have to make a time and value diagram as follows:
6 0 d a y s
r = 1 1 %
1 J u l y 2 0 0 6 1 A u g u s t 2 0 0 6 3 0 A u g u s t 2 0 0 6
R p . 1 0 0 .0 0 0 .0 0 0 R p . 1 0 1 .8 0 8 .2 1 9 ,2 0
2 9 d a y s
d = 1 5 %
The amount of the promissory note at the due date is:
60
S = Rp. 100.000.000 × 1 + 0.11
365
= Rp. 101.808.219,2
The amount received by the seller on August 2006 is:
29
P = Rp. 101.808.219,2 1 − 0.15
365
= Rp. 100.594.888,4
b. Bank will earn Rp. 1.213.330,8 for an investment in amount of Rp. 100.594.888,4
during 29 days.
Therefore:
P = Rp. 100.594.888,4
SI = Rp. 1.213.330,8
t = 29 days
Thus,
SI
r=
Pt
Rp.1.213.330,8
= 29
Rp.100.594.888,4 ×
365
= 0.15181 or 15.18%
The other way is by calculating r which is equivalent with d =15%:
d 0.15
r= = = 0.15181 = 15.18%
1 − dt 29
1 − 0.15
365
c. Mr. Bachtiar will receive interest in amount of Rp. 594.888,4 for an investment in
amount of Rp. 100.000.000 during 31 days. The interest rate that he gets is:
SI Rp.594.888,4
r= = = 0.07004 = 7%
Pt 31
Rp.100.000.000 ×
365
Example 2.8
On 15 April 2006, Mr. Emil signs a promissory note in amount of Rp. 80.000.000.
That promissory note will be due within two months with interest of 12%. On 10 may
2006, the promissory note holder sells it to the bank by expecting 13% interest rate.
What is the amount received by the holder?
Answer:
6 1 d a y s
r = 1 2 %
1 5 A p r i l 2 0 0 6 1 0 M a y 2 0 0 6 1 5 J u n e 2 0 0 6
R p . 8 0 .0 0 0 .0 0 0 R p . 1 0 1 .8 0 8 .2 1 9 ,2 0
3 6 d a y s
d = 1 3 %
The amount due of that promissory note is:
61
S = Rp.80.000.0001 + 0.12 = Rp.81.604.383,56
365
The amount received by the promissory note holder is:
−1
36
P = Rp.81.604.383,561 + 0.13 = Rp.80.571.304,91
365
Example 2.9.
On 21 April 2006, Khalid buys goods in amount of Rp. 5.000.000. If he pays in cash,
he will get discount in amount of 4%. To utilize the discount, he signs a 90 days non
interest bearing note at a bank which imposes 9% discount rate. What is the nominal
amount of that note in order to receive the exact amount of cash to pay the goods?
Answer:
Cash discount = 4% × Rp. 5.000.000 = Rp.200.000
The seller needs cash in amount of:
= Rp. 5.000.000 – Rp. 200.000
= Rp. 4.800.000
P = Rp. 4.800.000
d = 9%
t = 90 days
P Rp.4800000
S= = = Rp.4.908.938,08
1 − dt 90
1 − 0.09
365
2.5CASH DISCOUNT
In order to encourage earlier payment, a lot of producers and wholesalers offer cash
discount for the payment before the due date. The amount of discount and the
requirements are usually stated in credit terms, such as 2/10, n/30, which means the cash
discount in amount of 2% will be given if the payment in done within 10 days. If not, the
total amount should be settled within 30 days.
The buyer that uses the cash discount, in practice will receive discount or interest in
advance in the form of cash discount. Usually, the effective interest rate that is earned fro
this treatment is very high.
Example 2.10.
A seller buys an office equipment in amount of Rp. 40.000.000 with credit term of 4/30,
n/100. What is the effective interest rate offered to that seller? (Note: if the seller wants to
get the discount, he will pay the amount on the 30th day and if not, he must pay the
equipment on the 100th day. In other words, there is a 70 days timing difference.
Answer:
The difference in amount paid or discount is 4%, or Rp. 40.000.000 × 4% = Rp.
1.600.000
P = Rp. 40.000.000 – Rp. 1.600.000 = Rp. 38.400.000
SI = Rp. 1.600.000
70
t=
365
SI Rp.1.600.000
r= = = 0.21726 = 21.73%
Pt 70
Rp.38.400.000 ×
365
or
365 0.04
r= × = 0.21726 = 21.73%
70 0.96
If the above seller has no cash, but he has across to borrow money, the highest interest
rate that still gives profit to that seller to borrow money in order to get the discount is
21.73%. If the borrowing interest rate is less than 21.73%, that seller should borrow the
money because the cash discount that he may get will be bigger than the interest expense
that should be paid for the same period of time.
CHAPTER 2 – EXERCISES
1. How much is the discount from an amount of Rp. 200.000.000 during 6
months at a discount rate of 10% p.a.?
2. How much is the discount from an amount of Rp. 15.000.000 during 8
months at a discount rate of 12% p.a.?
3. Karina borrows Rp. 500.000 during 6 months from Brutus who gives a
discount rate of 9%. How much is the discount imposed and how much is the amount
received by Karina?
4. Continuing Problem Number 3 above, if Karina would like to receive an
exact amount of Rp. 500.000, how much amount should she purpose?
5. Calculate the present value of money in amount of Rp. 60.000.000 that
will be due within 1 year with an interest rate of 12%
6. How much is the effective interest rate from a credit term of 2/10, n/30
from earlier cash payment?
7. If it is known that the discount rate of a bank is 12%, how much is the
equivalent interest rate for the period of 6 months?
8. If it is known that the interest rate of a bank is 12%, how much is the
equivalent discount rate for the period of 3 months?
10. What is the interest rate that makes an amount of Rp. 12.000.000, in the
next 8 months has a present value of Rp. 11.320.754,72?