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HOME DEPOT WORKING CAPITAL AND SHORT-TERM MANAGEMENT: THE COST OF TAKING A CASH DISCOUNT ON ACCOUNTS PAYABLE

Home Depot, the largest home improvement retailer in the world, is on the cutting edge of retail innovations. Much of their quick and steady rise to success is attributed to their approach to creating new customers and cultivating future customers. Through an idea called Home Depot University, adults take a four week comprehensive course in home improvement techniques which, of course, illustrate how the products sold by Home Depot can be used to enhance and modernize homes. The potential of kids as customers has not slipped their attention either. A program, known as "Our Kids Workshops," teaches children not only safety and creativity, but also plants a loyalty seed for the future. Another means by which Home Depot has differentiated themselves from their competition is by marketing what are called proprietary brands. This simply means that the product lines are only offered at Home Depot. Once customers adopt the product, they cannot buy it elsewhere. This is a way for Home Depot to protect their customer base from discount retailers who compete purely on price and drive down profit margins. One of Home Depot's proprietary brands is RIDGID who produce everything from power tools to wet/dry vacuums and air filtration systems. When Home Depot buys products from RIDGID, they use credit and have 45 days to make full payment on these accounts payable. However, if Home Depot wants to take advantage of RIDGID's 2% cash discount offer, they must pay within 15 days. To simplify record keeping, RIDGID uses the end-of-month (EOM) method when determining the beginning of the credit period. This simply means that any sales made throughout the month will have a starting credit period beginning on the first day of the next month. For example, Home Depot recently purchased a shipment of stationary bench-top power tools from RIDGID on December 23. Since RIDGID follows the EOM method, Home Depot's credit period does not start until January 1. If Home Depot wishes to take the 2% cash discount offered, they must make full payment by January 15. If not, they must pay the entire amount by February 14.

Questions

1. Calculate the exact cost of giving up the discount.

COST OF GIVING UP THE DISCOUNT CD: CASH DISCOUNT

CD X 360

(100%-CD) N

2% X 360 = 24.49%

(100%-2%) (45-15)

Cost of giving up discount: 24.49%

2. Home Depot's risk-free required rate of return is currently 7%. The firm's Weighted Average Cost of Capital (WACC) is 13.4%. Finally, the rate at which the company can borrow from a bank is 9.7%. Should Home Depot take the cash discount or should they wait until the full credit period is up? On which of the above three figures did you base your comparison? Explain.

Home Depot should take the

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