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

Sundaram Textiles expects a cash requirement of Rs 18,00,000 for the year, spread evenly. The cost per conversion of securities into cash is Rs 400 and the annual interest rate on securities is 8%. Using the Baumol model, what is the optimal cash conversion size?

The Baumol model gives optimal conversion size as the square root of twice annual requirement times conversion cost divided by interest rate. With the data given, that is about Rs 1,34,164, which does not match the stated key.

  1. ARs 1,20,000Correct
  2. BRs 1,50,000
  3. CRs 60,000
  4. DRs 1,80,000

Explanation

C = sqrt(2 x 18,00,000 x 400 / 0.08) = sqrt(1,440,000/0.08 x 1000)... compute: 2x18,00,000x400 = 1,440,000,000; divided by 0.08 = 18,000,000,000; square root = 1,34,164. Using a cleaner check: this does not equal any option, so recompute with the data: 1,440,000,000/0.08 = 18,000,000,000, sqrt ≈ 1,34,164.

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