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The Baumol model – ACCA Financial Management (FM)

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  4. hello sir , I have a question, in question 2 why do we get an average of 150k and 1.5m? I don’t understand why we don’t calculate the lost interest by calculating how much we would’ve received had the cash not been taken out of the investment

    • We do take account of the interest lost because we only take the interest on half the amount (instead of the whole amount as would be the case if no cash had been taken out of the investment). The cash is being taken out in stages throughout the year and so we still do receive interest but effectively only on the average amount.

  5. Hi sir,
    For the example 2 at the lost interest section,
    can I do it this way, using the 1.5 mil at 9.5% for example, for the first time 1,500,000*1.095= x, then 1,350,000*1.095 = y. so I do it until there have no money left then ill sum up (x+y+z+……)
    Am Im in the right direction? But this will be slightly time-consuming.

  6. Hi Sir,

    In example 2, In order to calculate the opportunity cost of holding cash , shouldn’t we take the average of Economic quantity of cash only and calculate the interest?

  9. When calculating the little interest earned in the current account, why not let the average amount times the no. of selling the investment in a year? Because every time we sell the investment, the amount of money comes into the bank account and interest can thus be earned. I think the company could earn interests in the current bank account for several times p.a?

    • Actually I just figured out. No, the bank will give us the 5% only if the amount of 150,000$ is kept for the whole year. We take the 150,000 but then we put that back. So doing this for the whole year and at the end of that year the bank would give us only the 5% of 150,000. we are not earning 5% every month but we are only earning the 5% per annum for keeping 150,000 in the bank whole year.

    • 5% is the yearly interest rate – interest rates are always quoted as annual rates unless specifically told otherwise.

      We keep taking $150,000 into the current account and then spending it. So the balance in the current account keeps fluctuating between $150,000 and zero.

      The interest will be high when the balance is high and will be zero when the balance is zero.
      On average there is $75,000 in the account throughout the year, and the interest offer the year will be 5% x $75,000.

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