The Baumol model – ACCA Financial Management (FM)
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Hi sir,
Why we can’t sell investments in amount of 1.5m in the end of the year? We will lose only interest 5% in amount of 75000 and fee for one transaction in amount of 150?
Greetings sir. I don鈥檛 understand. What you didn鈥檛 like about this model compared to the other ? What didn鈥檛 you find practical ?
I have never come across a company that withdraws a fixed amount at fixed intervals from an amount invested. However that is obviously irrelevant as far as the exam is concerned 馃檪
Hello sir
For question c.) why don’t we subtract the total cost of sales (1500)and instead add it in finding the total cost incurred?
If you are referring to the $150 each time, then this is a cost of selling investments and therefore it is added in arriving at the total cost.
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.
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.
It would be ridiculously time consuming and not something to even consider in the exam 馃檪
Thanks for clearing this up
You are welcome 馃檪
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?
No. Over the year they will have sold a total of 1,500,000 of investments.
Yes, but I don’t quite understand why we add the total investments and the EOQ and take the average of those. If we sell a total of 1.5 million worth of investments over the year, wouldn’t adding these together increase the average opportunity cost?
At the beginning they will only be losing interest on the first 100,000 sold. By the end they will be losing interest on the whole 1,500,000 sold. So overall they are losing interest on the average of the two.
Ohhh that makes so much sense now! Thanks a ton John.
70710.67812 when i use the formula and it is really better than in a and c
EQC is used to determine the optimum quantity of cash that the business should transfer each time together with the cost implication of doing so.
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?
I have the same question
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.
Why we used average Interes in part (a) for lost interest?