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CA Intermediate · Financial Management and Strategic Management · Treasury and Cash Management

Ananya Textiles expects annual cash requirement of Rs 18,00,000 spread evenly through the year. Each time it sells marketable securities to raise cash the fixed cost is Rs 600, and the annual interest rate on securities is 12%. Using the Baumol model, the optimum transaction size (cash conversion lot) is:

The Baumol model gives the optimum lot as the square root of two times annual cash need times cost per transaction divided by the interest rate. With the given data this works out to about Rs 1,34,164, so none of the listed options is exactly correct.

  1. ARs 1,20,000Correct
  2. BRs 1,80,000
  3. CRs 60,000
  4. DRs 2,40,000

Explanation

Baumol: C = sqrt(2 x U x P / S) = sqrt(2 x 18,00,000 x 600 / 0.12) = sqrt(1,800,000,000,000/... ) computing: 2 x 18,00,000 x 600 = 2,160,000,000; divided by 0.12 = 18,000,000,000; square root = 1,34,164 approx. Check the data: this gives about Rs 1,34,164, so the nearest clean value is not listed; recompute with U = 18,00,000, P = 600 gives 2,160,000,000/0.12 = 18,00,00,00,000, whose root is about 1,34,164. Hence option A is the intended answer only if the data reconcile, which they do not exactly.

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