1. The Baumol model

You are the newly appointed senior assistant to Lexi Jones, the CFO of McMurphy Inc., a successful company with $90 million in sales. Following up on a comment made during the board meeting last week, Lexi Jones has asked you to verify that the cash transfers between the companys portfolio of marketable securities and its principal bill-paying checking account are the lowest cost possible. Currently, McMurphy tends to fund its monthly cash requirements by either selling its marketable securities or borrowing funds in increments of $105,183.

You have collected the following data and only need to complete your calculations to address Lexi Joness concerns and answer the questions that follow. (Note: To make your computations easier, round all dollar amounts to the nearest whole dollar.)

Cash Transfer Data for McMurphy Inc.

Monthly cash requirement	$583,333
Return earned on marketable securities portfolio	10.25%
Securities-to-cash conversion cost	$25.00

Given the cash transfer data for McMurphy, complete the following table.

	Cash Transfer Analysis for McMurphy Inc.
	Activities Suggested by the Baumol Model	Current Activities
Transaction size		$105,183
Average cash balance
Total annual cash-related holding costs
Annual number of transactions
Total annual transaction costs
Total annual cost of cash balances

Should you recommend to Lexi Jones that the size and frequency of the companys cash transfers be changed? Why?

Yes, because the total cash costs associated with the current transfers are less than those associated with transfers based on the Baumol model.

No, because the total holding costs associated with transfers based on the Baumol model are less than those associated with the current transfers.

No, because the total transaction costs associated with transfers based on the Baumol model are greater than those associated with the current transfers.

Yes, because the total cash costs associated with transfers based on the Baumol model are less than those associated with the current transfers.