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Using Baumol's model, design an alternative cash management policy and calculate the cost savings that the alternative policy would achieve.

1. Under the term of government contract, ABC Ltd receives a cheque for 100000 every 20 weeks. these funds are then spent in steady stream until the next cheque is received. At present, ABC's policy is to hold $20000 in cash and to deposit the remaining $80000. Every few weeks, a further $20000 is withdrawn and spent. the interest rate is 0.4 per cent per week(or 8 per cent of the amount transacted.

Using Baumol's model, design an alternative cash management policy and calculate the cost savings that the alternative policy would achieve.

2. Explain how the company's credit policy with regards to accounts receivable may affect shareholder wealth.

3. Briefly describe an aggressive working capital management strategy and identify the associated risk- return trade-offs.

Solution Preview

Q1.The firm's total cash requirement is 100,000/20=5000 per week or 5000*52=260,000per year, assuming cost per transaction as $ 7, balance and rate of interest is 8% than optimum cash is Sq.root of2* 7*260000/.08 this is 6745

The average cash balance in the above given case is 10,000
Therefore extra cost is incurred 10000-6745= 3255 and the annual cost on ...

Solution Summary

Brief but clear sentences respond to posting. Computation shown for Q1.

$2.19