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A division requires $1.5m per year; cash use is constant throughout the year. Transaction costs are
$150 per transaction and deposit interest is generated at 7.5% and interest on short-term financial
securities is 12%.Required
What is the optimal economic quantity of cash transfer into this division’s sub-account and how
frequently?
A) $1,500,000 once a year
B) $77,500, 19 times a year
C) $61,200, 25 times a year
D) $100,000, 15 times a year (CORRECT)Option D is the right answer.
Hello tutor!!
They calculate the answer by putting 4.5% in denominator as holding cost for cash meanwhile, in the scenario above only two types of interest rates are given then how’s the 3rd interest rate they calculated ?
I am not sure what further explanation you require.
Have you watched my free lectures on the Baumol model where I explain the whole thing?
The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
I mean to say what does these two interest rate represent and why we use the difference of them ?
12% is the cost of borrowing finance. 7.5% is the interest earned on depositing cash.
So the net cost of holding cost is the 12% paid for borrowing it less the 7.5% earned from then depositing it.
Again, have you watched my free lectures on this?
Okay now I understood it clearly.
I will watch your lectures surely.
Thank you so much 🙂
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