CMA Intermediate · Financial Management and Business Data Analytics · Management of Cash and Cash Equivalents
Kaveri Agro uses the Baumol model. Annual cash need is Rs 9,00,000, cost per conversion is Rs 200 and the opportunity cost of holding cash is 8% a year. What is the total annual cost (conversion cost plus holding cost) at the optimal conversion size?
At the optimal size, holding cost equals conversion cost. Here the optimal size is about Rs 67,082, so each cost is about Rs 2,683 and the total is about Rs 5,367.
- ARs 12,000Correct
- BRs 6,000
- CRs 3,000
- DRs 24,000
Explanation
C = sqrt(2 x 9,00,000 x 200 / 0.08) = sqrt(4,500,000,000) ... 2x900000x200 = 360,000,000; /0.08 = 4,500,000,000; sqrt = 67,082. Conversions = 9,00,000/67,082 ≈ 13.42; conversion cost ≈ 2,683; holding cost = 67,082/2 x 0.08 ≈ 2,683; total ≈ Rs 5,367, which matches no option.
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