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Cash Management using Baumol Model

1) Company A is using the Baumol model to find cash balances. Recently the model called for an average balance (C*/2) of $500 and the rate on marketable securities was 4%. A rapid increase in interest rates has driven the interest rate up to 9% What is the appropriate average cash balance now?

2) Company A receives $2 million in payments of which $500,000 is needed for cash payments made during the next year. Each time the company deposits money in its account, a charge of $2.00 is assessed to cover certain admin costs. If the company can hold marketable securities which yield 5% and then convert these securities to cash at a cost of only the $2 deposit charge, what is the total cost for one year of holding the minumum cost cash balance based on the Baumol model?

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1) Company A is using the Baumol model to find cash balances. Recently the model called for an average balance (C*/2) of $500 and the rate on marketable securities was 4%. A rapid increase in interest rates has driven the interest rate up to 9% What is the appropriate average cash balance now?

The Baumol Model
C = square root of ( 2 x Total Demand during the period x Fixed Transaction Cost)/ Interest rate
1000 = square root of ( 2 x Total Demand during the period x Fixed Transaction Cost)/ 4%
Or (Total Demand during the period x ...

Solution Summary

Calculates cash balance using Baumol Model.

$2.19