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Cash Management Models and Calculations

The document contains solutions to assignment questions on cash balance optimization models, average collection period calculation, and effective annual rate calculation. It applies the Baumol and Miller-Orr models to calculate optimum cash balances of Rs. 200,000 and between Rs. 804,338.73 and Rs. 813,016.20 respectively. It further calculates the average collection period of a company as 30 days based on given payment terms. Finally, it determines the effective annual rate of a transaction if the buyer gives up a 2% discount as 27.864%.

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KASHIF
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76 views3 pages

Cash Management Models and Calculations

The document contains solutions to assignment questions on cash balance optimization models, average collection period calculation, and effective annual rate calculation. It applies the Baumol and Miller-Orr models to calculate optimum cash balances of Rs. 200,000 and between Rs. 804,338.73 and Rs. 813,016.20 respectively. It further calculates the average collection period of a company as 30 days based on given payment terms. Finally, it determines the effective annual rate of a transaction if the buyer gives up a 2% discount as 27.864%.

Uploaded by

KASHIF
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

FIN622 - Assignment No.

02
Semester: Fall 2020 Submission Date: 01-02-
Student ID: MC190405830 2021

SOLUTION:

I. Optimum level of cash balance by Baumol Model:

Amount of cash to be used in each period (A) Rs. 800,000


Baumol
Fixed cost of obtaining new funds (F) Rs. 1250
Model
Interest cost of holding cash (I) 5%

2∗A∗F
Optimum level of cash balance (C) =
√ I
2∗800,000∗1250
Optimum level of cash balance (C) =
√ 0.05
2,000,000,000
Optimum level of cash balance (C) =
√ 0.05
Optimum level of cash balance (C) = √ 40,000,000,000
Optimum level of cash balance (C) = 200,000 Rupees

II. Optimum level of cash balance by Miller-Orr Model:

Variance of daily cash flow (𝛔2) Rs. 121,000


Miller-
Orr Transaction cost (F) Rs. 90
Model
Daily interest rate (I) 0.01%

0.75∗F∗σ 2
Spread (Z) = 3 x
√
3

I
FIN622 - Assignment No. 02
Semester: Fall 2020 Submission Date: 01-02-
Student ID: MC190405830 2021

0.75∗90∗121,000
Spread (Z) = 3 x
√
3

0.01%

8,167,500
Spread = 3 x
√
3

0.0001

Spread = 3 x √3 81,675,000,000

Spread = 3 x 4338.73

Spread = 13016.20

Maximum cash balance = Minimum cash balance + Spread


Spread
Return Point = Minimum cash balance +
3

Let’s assume that minimum cash balance is 800,000 than:

Maximum cash balance = 800,000 + 13016.20 = 813,016.20


13016.2027
Return Point = 800,000 + = 804,338.73.
3

III. Average Collection Period (ACP):

Collection period 40 days

ACP Terms /offer of 2/15, net 40

Customer avail discount 40 %


FIN622 - Assignment No. 02
Semester: Fall 2020 Submission Date: 01-02-
Student ID: MC190405830 2021

It means that 40% customers have availed the 2% discount by paying within 15 days and
remaining 60% have paid full invoice on 40th day. Now the ACP will be as follows:

= 40% x 15 days + 60% x 40 days


= 0.4 x 15 days + 0.6 x 40 days
= 6 days + 24 days
= 30 days

IV. Effective annual rate (EAR):

Sale term 2/10, net 40


EAR
Transaction amount Rs. 500,000

If buyer gives up discount what will be Effective Annual Rate (EAR) for the given up
discount? (03Marks)

Solution:

Sale Terms / Offer = 2/10, net 40

Discount = 2%
Full Payment days = 40 days
Discount Payment days = 10 days

Full Payment days – Discount Payment days = 40 – 10 = 30 days


365/ (Full Payment days – Discount Payment days)= 365 / 30 = 12.1667

100 % - Discount percentage = 100%-2% = 98 %


1 / (100 % - Discount percentage) = 1 / 98 % = 1.020408

Effective annual rate (EAR) = (1.020408 ^ 12.1667) – 1


= 27.864 %

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