Barenbaum Industries projects that cash outlays of $4.5 million will occur unifo

Question

Barenbaum Industries projects that cash outlays of $4.5 million will occur uniformly throughout the year. Barenbaum plans to meet its cash requirements by periodically selling marketable securities from its portfolio. The firm’s marketable securities are invested to earn 12 percent, and the cost per transaction of converting securities to cash is $27. a. Use the Baumol model to determine the optimal transaction size for transfers from marketable securities to cash. b. What will be Barenbaum’s average cash balance? c. How many transfers per year will be required? d. What will be Barenbaum’s total annual cost of maintaining cash balances? What would the total cost be if the company maintained an average cash balance of $50,000 or of $0 (it deposits funds daily to meet cash requirements)?

Explanation / Answer

Equational Representations in Baumol Model of Cash Management:
Holding Cost = k(C/2)
Transaction Cost = c(T/C)
Total Cost = k(C/2) + c(T/C)

Where T is the total fund requirement, C is the cash balance, k is the opportunity cost & c is the cost per transaction

the optimum level of cash c2= 2FT/i where F is the fixed cost for transaction and T is the total cash needed for the time period

c2=2*27*4,500,000/0.12

c=45000$= cash balance

avg cash balance= cash conversion size/2

cash conversion size= 45000*2= 90000

no.of converions = 4500000/90000=50

optimal transaction size=4500000/27*50=3,333

total annual cost = 0.12(45000/2)+4500000*27/45000=5400

with avg cash bal 50000:

annual cost= 0.12*50000+4500000*27/50000*2=7215

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.