FIN429 Project Assessment: first semester 2021/2022 Academic year

Dream Gems & Jewellery is a new SME start-up (been in operation for four years now) that promises keen competition in the Gem and Jewellery industry. Its competitors include Yaseen Gems & Jewellery and others who are doing well in the industry.

Dream Gem & Jewellery operations became profitable in the first two years until the managers decided to open another branch in a busy shopping centre in Manama. The opening of the new branch saw tremendous fluctuations in cash flows which overwhelmed Dream Gems & jewellery managers as they find it difficult managing the cash flows to ensure prudence in operations. For instance, on some trading days, they hold so much cash in their transaction accounts that the cash is left idle for days. On other trading days, they quickly run out of cash to pay suppliers, and they do not also have enough credit lines to fall to. Dream Gems & Jewellery managers have become worried about the situation and forecast that if things go on without a proper cash management system put in place, they risk losing their business model. Their competitors will take advantage and crowd them out of business.

In a consultative meeting held to address the situation, they invited a financial management expert, taking several decisions to nib the problem in the bud. Among the critical decisions taken includes the following:

1. i. Dream Gems & Jewellery should set the lower cash limit (L) and upper cash limit (H) so that any time the cash limit reaches any of those points, it will trigger the company to move (H – Z) and (Z – L) BD respectively.
2. ii. The financial management expert analysed the historical net cash flows of Dream Gems & Jewellery and computed the variance of the daily cash flows to be 160,000 BD. The standard deviation is taken into account for the daily variance.
3. iii. The cost per transaction for buying and selling marketable securities F, is assumed to be fixed, at 89 BD
4. iv. The opportunity cost for holding cash in a year is 8.6%. The interest rate and the variance are all based on the same length of time.
5. v.The tolerable lower cash limit (L) has been established as 2,000 BD
6. vi. The cash flow movement is explained in the graph below

Cash Movement in The Miller-Orr Model

As a student of finance studying working capital management, you are required to analyse the information above and advise Dream Gems & Jewellery based on the following effects:

1. 1. Mention and discuss one reason each why the cash management expert wants Dream Gems & Jewellery to set cash balances to (H) and (L), thereby culminating the company to move (H – Z) and (Z – L) BD, respectively?
2. 2. What is the spread or cash return point level that will not move the cash above (H – Z) or (Z – L)? Explain your answer.
3. 3. What is the upper cash limit (H) that will be needed to enable the company to move (H – Z) BD to purchase securities? What is the amount in BD that will be needed to invest in securities? Explain your answers.
4. 4. If the Miller-Orr assumptions are valid, what is the average cash return that will allow the company to remain in liquidity? Explain your answer.
5. 5. Assuming Dream Gems & Jewellery does not understand the number of securities to purchase in a year if they forecast the cash disbursement to be equal to the daily variance. How many security sales will the company have in a year that will help them to plan ahead?
6. 6. Describe what will happen to the lower cash limit, the upper cash limit, and the spread (the distance between the two) if the variation in net cash grows. Give an intuitive explanation for why this happens. What happens if the variance drops to zero?
7. 7. What is the advantage of the Miller-Orr model over the Baumol-Allais-Tobin (BAT) model?

30 MARKS

Note: refer to FIN429 lecture PPTs pages 17 to 30 of chapter three (Cash Holdings) for guidance.

References

Al-Najjar, B., Belghitar, Y. (2011). Corporate cash holdings and dividend payments: Evidence from simultaneous analysis. Managerial and Decision Economics, 32(4), 231–241.

Amess, K., Banerji, S., Lampousis, A. (2015). Corporate cash holdings: Causes and consequences. International Review of Financial Analysis, 42, 421–433.

Chen, Y. R. (2008). Corporate governance and cash holdings: Listed new economy versus old economy firms. Corporate Governance: An International Review, 16(5), 430–442.

Habib, A., Hasan, M. M. (2017). Social capital and corporate cash holdings. International Review of Economics & Finance, 52, 1–20.

Miller, M.H and Orr, D (1966). A model of the demand for money by firms. Quarterly Journal of Economics 413 - 435