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CMA Intermediate · Financial Management and Business Data Analytics · Management of Cash and Cash Equivalents

Anand Pharma has ₹20,00,000 of surplus cash for 30 days. Option 1: a bank deposit paying 6% p.a. simple interest with no charges. Option 2: a liquid fund expected to return 7% p.a. with an entry cost of ₹1,500 and an exit cost of ₹1,000 (total ₹2,500). Using a 360-day year, which is the better option and by how much in net return for the 30 days?

Option 1, the bank deposit, is better by about ₹833. It earns ₹10,000 in 30 days, while the liquid fund earns ₹11,667 gross but only ₹9,167 after ₹2,500 of transaction costs. The costs outweigh the extra 1% yield over such a short period.

  1. AOption 1 is better by ₹1,500 approximately
  2. BOption 2 is better by ₹1,000 approximately
  3. COption 1 is better by ₹833 approximatelyCorrect
  4. DOption 2 is better by ₹2,500 approximately

Explanation

Option 1 interest = 20,00,000 x 6% x 30/360 = ₹10,000. Option 2 gross = 20,00,000 x 7% x 30/360 = ₹11,667; net of ₹2,500 costs = ₹9,167. Option 1 is better by 10,000 - 9,167 = ₹833. Ignoring the costs would wrongly favour Option 2 by ₹1,667.

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