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Dear Sir
I watched your lecture on this topic. It seems like companies would be setting a target cash balance (return point of $10,000 in your lecture) and a minimum cash balance. However, when we use the Miller-Orr formula, the return point becomes something that is decided by the formula and not be management. Furthermore, the return point should intuitively be the mid-point of the upper and lower limit but it is not. Could you pls explain?
Thanks.
The return point is not a target and as you rightly say it is determined by using the formulae – only the lower limit is determined by the company depending on the minimum cash needed to run the business. The return point and the upper limit are determined (by the formulae) to maximise the net of the interest earned less the transaction costs. (Because these costs differ it is not intuitive to expect the return point to be in the middle)
To explain the formulae requires an understanding of standard deviations and the normal distribution but there is no way I am going to prove if for you here given that you cannot be expected to prove it in the exam.
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