(Using EOQ for cash/securities management) Chemcon Corporation sells various industrial supplies used for general-purpose cleaning. Approximately 85 percent of its sales are to not-for-profit and governmental institutions. These sales are on a contract basis with an average contract length of 2 years. A1 Stanly, Chem- con’s treasurer, wants to initiate a system that will maximize the amount of time Chemcon holds its cash in the form of marketable securities. Chemcon currently has $9 million of securities that have an expected annual earnings rate of 8 percent. Chemcon is expecting a cash drain over the next 12-month period. Monthly cash outflows are expected to be $2,650,000, but inflows are only ex¬ pected to be $2,500,000. The cost of either buying or selling securities is $125 per transaction. Stanly has heard that the EOQ inventory model can be applied to cash management. Therefore, he has decided to employ this model to deter¬ mine the optimal value of marketable securities to be sold to replenish Chem- con’s cash balance.

a. Use the EOQ model in the chapter to

(1) explain the costs A1 Stanly is attempting to balance in this situation, and

(2) calculate the optimal dollar amount of marketable securities Stanly should sell when Chemcon needs to replenish its cash balance.

b. Without prejudice to your solution in part a(2), assume that the optimal dollar amount of marketable securities to he sold is $60,000.

CHAPTER 17 Control of Inventory and Production 803

(1) Calculate the average cash balance in Chemcon’s checking account that will be on hand during the course of the year.

(2) Determine the number of times during the year that Stanly will have to sell securities.

c. Describe two different economic circumstances applicable to Chemcon that would render its use of the EOQ inventory model inappropriate as a cash management model.

(CMA adapted)