You work in the procurement department, a key part of the Purchase to Pay portion of the value chain, for Mumford’s Supermarket, is a regional chain of stores in the Midwest. Your main supplier is the McLane Company Inc., a national distributor based in Texas with distribution assets that surround your stores.
McLane has offered Mumford’s a 2% discount for orders paid within 10 days, in return for Mumford’s committing to increasing average order sizes (and therefore total purchase) by 10%. You are charged with evaluating this proposal and recommending whether to accept it or not. Mumford’s normally orders $1,000,000 every 45 days from McLane, and would shift purchases equal to the 10% from another supplier who it pays in 75 days, in order to earn the 2% discount. Normally, on the base $1,000,000 of purchases, Mumford’s has been paying McLane in 45 days with no discount. The Mumford’s annual opportunity cost of capital is 10%.
Would Mumford’s be wise to take the discount in return for paying earlier and committing to increase its purchases by 10% from McLane? How would you determine the economics of this tradeoff? Assume the contract has no expiration date (a perpetuity).
- Compare the returns with this tradeoff (APR and EAR) vs. its opportunity cost of capital.
- Determine the NPV of the decision under the new policy for Mumford’s, assuming the contract is in place forever.
- Identify the working capital movements and WC implications of this change for Mumford’s.
- What are some strategic and risk considerations for Mumford’s in making this change?
