Comments

  1. avatar says

    Dear John,
    Its( $1.5M ) is our requirement and we have this money tied-up in the investment. Now we are taking it off, then why we have used to call it as selling investment. To whom we are selling, its not that we are picking it off from the current investment and re-filling our requirement throughout the year. So what does it mean by selling investment?

    Many Thanks

    • Avatar of johnmoffat says

      There are various places that you might have invested the money – it might be invested in shares or government securities. If you want to get the money out then you need to sell some of the investments. (It doesn’t matter who you sell them to – you sell them on the stock exchange).

  2. Avatar of massivecodedake says

    Dear John, I have two questions about your workings.The first one is that as we will lose the whole year’s interest from the investment once we withdraw the amount from investment.Why we need to calculate the average amount we withdraw from the investment when we calculate the lost interest?(Why just can”t be 1500000/EOQ*9.5%?) The second question is I remember F2 says that when the company order their goods in EOQ,the total order cost will equal to the
    total holding cost. Why your workings doesn’t show this conclusion? THX John!

    • Avatar of johnmoffat says

      In answer your first question, we are not losing a whole years interest. In part (a), we withdraw 150,000 at the start of the year and so lose a whole years interest on that. The next 150,000 will be withdrawn a few weeks later and so we will only lose part of a years interest on it, the next one a few weeks after that and so so. Instead of working out the interest lost on each withdrawal separately, we have calculated the interest lost on the average balance for the year.
      (Also, taking 1500000/EOQ x 9.5% would make no sense at all – interest is only on a cash amount and 1500000/EOQ is not a cash amount).

      With regard to your second question, in inventory control, at the EOQ the total order cost will indeed equal the total holding cost – but only if we ignore any fixed costs. The same happens here. If you look at the costings, then there is a term 1500000/2 x 9.5% which will be the same whatever the quantity of cash withdrawn each time. If this is removed from the costings then total order cost does equal total holding cost at the EOQ. (This is however irrelevant to both inventory control and to the Baumol cash model.)

  3. avatar says

    Hi Everyone,
    I have 2 questions which I really appreciate your help for. In the Practice Questions sheets, question number 5- Pearl plc, part b- Advise Emerald as to the most beneficial cash management policy:

    Question1: Average cash balances has been calculated as follows: $25,000/2= $12,500. Why did we divide it by 2?
    Question2: Should not the total income for the secured loan be: ($1.5m * 9%)=$135,000 instead of (%12 * $1.5m)=$180,000? if not, why not? Thanks a lot

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