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?

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.

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.

joelsasi says

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?

John Moffat says

No. Over the year they will have sold a total of 1,500,000 of investments.

danielle.ezra says

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?

John Moffat says

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.

danielle.ezra says

Ohhh that makes so much sense now! Thanks a ton John.

boychenkove says

70710.67812 when i use the formula and it is really better than in a and c

Samuel Koroma says

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.

yukyo says

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?

aliahmed1994 says

I have the same question

aliahmed1994 says

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.

John Moffat says

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.