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king co

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › king co

  • This topic has 1 reply, 2 voices, and was last updated 8 months ago by John Moffat.
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  • Author
    Posts
  • May 22, 2022 at 9:30 am #656172
    AFNAAAN
    Member
    • Topics: 16
    • Replies: 12
    • ☆

    King Co is a decentralised organisation whose different divisions have approached the
    matter of cash control in different ways, partly because of their different circumstances.
    Assume 365 days in a year.

    The Western division is facing a two?year major capital investment programme for which
    significant funds need to be raised to meet the steady demand for cash. The division
    intends to use the ‘Baumol model’ to decide when to raise funds, which will be done by
    selling off investments currently earning 5% per annum. The transaction cost of these sales
    will be $500 per transaction and the total amount needed over the two years is $2,000,000.

    The Alpine division has no significant investment plans but finds itself regularly having to
    either sell investments to make funds available or invest surplus cash. This is because of
    the considerable variation in daily cash inflows, which has been quantified as having a
    standard deviation of $7,000. As a result, the division uses the ‘Miller?Orr model’ to
    determine when to invest and when to make sales, using the same transaction cost and
    investment rate as the Western division.

    required
    What does the Miller?Orr model suggest is the spread between the upper and
    lower limits of cash levels that the Alpine division should maintain?

    answer:Miller?Orr spread = 3 × (¾ × $7,000² × $500 ÷ (0.05/365))1/3 = $153,569

    my quetion is why did they divide interst rate by 365????

    May 22, 2022 at 4:32 pm #656194
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 51555
    • ☆☆☆☆☆

    Because it is the daily interest rate that we use in the formula.

    I do explain this in my free lectures on cash management! The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.

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