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

Under the Baumol model, Sundaram Ltd needs Rs 3,60,000 cash in a year, the cost per conversion is Rs 250 and the annual holding cost is 10%. What is the optimum size of each conversion?

Using the Baumol formula, the optimum conversion size is the square root of 2 times 3,60,000 times 250 divided by 0.10, which equals about Rs 42,426. Ignoring the factor of 2 or misusing the holding rate gives the wrong figures.

  1. ARs 42,426Correct
  2. BRs 60,000
  3. CRs 30,000
  4. DRs 1,34,164

Explanation

C = sqrt(2 x 3,60,000 x 250 / 0.10) = sqrt(1,800,000,000) = about Rs 42,426. Rs 60,000 results from omitting the factor 2 incorrectly in a different way, and Rs 1,34,164 results from forgetting to divide by the holding cost properly.

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