The management of cash, or treasury management, is perhaps the most important aspect of working capital management of a firm. There should always be an adequate amount of cash available to the corporation. If there is an unexpected shortage of cash, the company must also have proper means to raise the needed cash. This requires careful planning and cash budgeting. Cash is a necessary resource in business, but too much of it is also wasteful. Usually corporations keep cash in a checking account, or several accounts, and the excess cash in marketable securities through a brokerage firm.
These days it is possible to keep both the checking account and the brokerage account at a single institution. For instance, a corporation can have checking and brokerage accounts at PNC Bank. It is also possible to have both these accounts at a brokerage firm, such as Merrill Lynch. There are some restrictions, however, on the checking accounts maintained at a broker. At one time, the banks were not allowed to sell stocks, and the brokers could not give check-writing privileges to customers. However, the current trend is to blur the distinction between banks and brokers. The policy of the Federal Reserve is to move in that direction.
Large corporations, such as Walmart, Ford, or Microsoft, have billions of dollars in cash. They have full-time staff who track the cash flows and cash balances constantly. Even smaller companies have to watch their cash accounts carefully
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SOLUTIONS 5.1. Campbell Corporation uses Baumol model to manage cash. The cost of transferring money from a money-market fund, which pays 6% interest on balances, to a checking account is $32 per transaction. Campbell needs $13 million annually to pay its bills. Find the annual cost of interest forgone. $3533 ? Solution: Annual requirement of cash (A) = $ 13 million Transaction cost (T) = $ 32 per transaction Opportunity cost of holding cash (R) = 6% According to Baumol model to manage cash Total cost = Transaction cost + Opportunity cost Let C* be the optimum cash balance that minimizes the cost of holding cash Transaction cost = A x T C* Opportunity cost = C* x R 2 Total cost = A x T + C* x R C* 2 Differentiating with respect to C* we get 0 = - A x T + 1 x R C*2 2 - A x T = 1 x R C*2 2 C* = v(2AT) / R Therefore C* = v(2*13,000,000* 32) / 0.06 C* = v13866666666.67 C* = $ 117756.81 The annual cost of interest foregone is the opportunity cost Opportunity cost = C* x R 2 =($ 117756.81/2) *0.06 = $ 3533 The annual cost of interest foregone is $ 3533. Created with an evaluation copy of Aspose.Words. To discover the full versions of our APIs please visit: https://products.aspose.com/words/ Created with an evaluation copy of Aspose.Words. To discover the full versions of our APIs please visit: https://products.aspose.com/words/ 141 5.2. Genentech Corporation, by analyzing its weekly balances in its checking account, has determined that the variance of cash flows is $3,000,000. Further, the cost of transferring money from the checking account to a money market account is $65 per transfer. The interest on the checking account is 1%, while that on the market account is 6%. Genentech wants to keep $5,000 as a minimum balance in the checking account. Find the annual cost of...