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 $262,000 but expects the standard deviation in net daily cash flows to be $13,700, the effective annual rate on marketable securities to be 3.0 percent per year, and the trading cost per sale or purchase of marketable securities to be $36.00 per transaction.

What will be its optimal upper cash limit?

Veggie Burgers, Inc., would like to maintain its cash account at a minimum level of $262,000 but expects the standard deviation in net daily cash flows to be $13,700, the effective annual rate on marketable securities to be 3.0 percent per year, and the trading cost per sale or purchase of marketable securities to be $36.00 per transaction.

Explanation / Answer

optimal
cash balance z is computed as follows:

Z = 3[ (3F 2)/ 4I ]

F= Fixed costs of security transaction= 6

I= Daily interest rate on marketable securities= 3%/365= 0.00008219

2= Variance of daily cash flows= standard deviation^2= 13700*13700= 187690000

Optimal balance=

3[ (3*6* 187690000)/ 4* 0.00008219] = 21741

Optimal upper cash limit= 3Z= 21741*3= 65223

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