Veggie Burgers, Inc., would like to maintain its cash account at a minimum level

Question

Veggie Burgers, Inc., would like to maintain its cash account at a minimum level of $261,000 but expects the standard deviation in net daily cash flows to be $13,600, the effective annual rate on marketable securities to be 4.1 percent per year, and the trading cost per sale or purchase of marketable securities to be $35.50 per transaction. What will be its optimal cash return point? (Use 365 days a year. Do not round intermediate calculations and round your answer to 2 decimal places.) Optimal cash return point $

Explanation / Answer

Variance of daily cashflows = standard deviation ^2 = 13,600 ^ 2 = 184960000

Daily interest rate = (1+4.1%)^(1/365) - 1 = 0.0001101

Spread = 3 [(3/4 * transaction cost * variance of daily cash flows) / interest rate] ^ (1/3)

Spread = 3 [(3/4 * 35.50 * 184960000) / 0.0001101] ^(1/3) = 106491.4

Lower limit = 261,000

Optimal cash return Point = Lower limit + (1/3 * Spread)

Optimal cash return Point = 261,000 + (1/3 * 106491.4)

Optimal cash return Point = $ 296,497.88

Answer: Optimal cash return Point = $ 296,497.88

Hope this helped ! Let me know in case of any queries.

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