11 Baumol cash model. As a newly appointed financial assistant in Balder Enterprises you have been asked to assist the financial manager determine the Baumol cash model for the company. The financial manager estimates that the company’s total cash requirement for the coming year will be £5.4m. The cost of converting marketable securities to cash is £35 per transaction and the annual interest rate on short-term investments is 8 per cent.

(a) The financial manager has asked you to calculate the following:

(1) the optimal quantity of cash to withdraw from marketable securities each time the cash balances reduces to zero, that is, the ECQ;

(2) the number of conversion transactions each year;

(3) the average cash balance;

(4) the total cost.

(b) The financial manager has also asked you to recalculate total cost assuming the number of conversion transactions during the year is limited to 2 per month.

Compare this recalculated figure with your previous calculation of total cost in (a)

above. Comment on your findings.