Cash management model exercise 1. ABC Ltd., expects to need a total of £2m over the coming year. The interest rate is 10% and the fixed cost of a security transaction is £150. Using an appropriate cash management model, determine:

(i) ABC's optimal cash balance;

(ii) The number of transfers that will be required over the next year;

(iii) How often the cash balances will require replenishing?

(iv) The opportunity costs, trading costs and total costs.

 

1) optimal cash balance =£ 77,460 (Rounded off to Whole Number)

2) number of transfers that will be required over the next year = 25.82(Rounded Off to Two Decimals) OR ,26 Transfers(Rounded off to Whole Transfer)

3) How often the cash balances will require replenishing= 14.13645 Days i.e. 14 Days Approx

4) Trading Cost = £3873.00

Opportunity Cost = £3873.00

Total cost = £ 7746.00

Step-by-step explanation

• Annual Requirement of Cash (A) = £2 Million = £20,00,000

• Cost Per Security Transaction (O) = £150

• Annual Interest Cost (S) = 10% = £0.10 Per £

i. Calculation of ABC's optimal cash balance:

optimal cash balance= ?Square root of {(2 * Annual Requirement of Cash * Cost Per Security Transaction) / Annual Interest Cost}

= ? Square root of {(2 *A *O)/S}

= ? Square root of {(2 * 20,00,000 * 150)/ 0.10}

=?Square root of {6,00,00,00,000}

= 77,459.6669 , optimal cash balance =£ 77,460 (Rounded off to Whole Number)

ii. Calculation of number of transfers that will be required over the next year

Annual Cash Requirement / optimal cash balance

= 20,00,000 / 77460

= 25.81988

= 25.82(Rounded Off to Two Decimals)

=26 Transfers(Rounded off to Whole Transfer)

iii. Calculation of How often the cash balances will require replenishing:

= 365 Days / 25.81988 Transfers

= 14.13645 Days

= 14 Days Approx

iv. Calculation of opportunity cost, trading costs and total costs:

Trading Cost (25.81988*150)  = £3873.00

Add: Opportunity Cost = (77,460/2 )*0.10                = £ 3873.00

Total Cost                                             =£ 7746.00