Skip to content

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

Under the Baumol model of cash management, a firm expects to use Rs 6,00,000 of cash evenly over a year. Each conversion of marketable securities into cash costs Rs 300, and the opportunity cost of holding cash is 12% per annum. What is the optimal cash conversion size?

The optimal conversion size under the Baumol model is Rs 54,772. It equals the square root of twice annual cash requirement times cost per conversion, divided by the opportunity cost rate: sqrt(2 x 6,00,000 x 300 / 0.12), which gives roughly Rs 54,772.

  1. ARs 30,000
  2. BRs 54,772
  3. CRs 60,000Correct
  4. DRs 1,22,474

Explanation

Baumol: C = sqrt(2 x U x P / S) = sqrt(2 x 6,00,000 x 300 / 0.12) = sqrt(3,000,000,000) = about Rs 54,772? Check: 2x600000x300 = 360,000,000; divided by 0.12 = 3,000,000,000; sqrt = 54,772. So the correct value is Rs 54,772. Option Rs 60,000 is wrong because it is not derived from the formula.

Did you get it right without looking?

One question tells you little. A timed set on Treasury and Cash Management shows your real accuracy, how long you take and where you lose marks.

Practise Treasury and Cash ManagementFree diagnostic mock

More Treasury and Cash Management questions