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Basic

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PART SEVEN Short-Term Financial Planning and Management

4. Costs and the BAT Model Debit and Credit Bookkeepers needs a total of $4,000 in cash during the year for transactions and other purposes. Whenever cash runs low, it sells off $300 in securities and transfers the cash in. The interest rate is 6 percent per year, and selling off securities costs $25 per sale.

a. What is the opportunity cost under the current policy? The trading cost? With no additional calculations, would you say that Debit and Credit keeps too much or too little cash? Explain.

b. What is the target cash balance derived using the BAT model?

5. Determining Optimal Cash Balances The Bud Wiser Company is currently holding $600,000 in cash. It projects that over the next year its cash outflows will exceed cash inflows by $340,000 per month. How much of the current cash holding should be retained and how much should be used to increase the company's holdings of marketable securities? Each time these securities are bought or sold through a broker, the company pays a fee of $500. The annual interest rate on money market securities is 5.5 percent. After the initial investment of excess cash, how many times during the next 12 months will securities be sold?

6. Interpreting Miller-Orr Econoline Crush, Inc., uses a Miller-Orr cash management approach with a lower limit of $30,000, an upper limit of $125,000, and a target balance of $45,000. Explain what each of these points represents and then explain how the system will work.

7. Using Miller-Orr Slap Shot Corporation has a fixed cost associated with buying and selling marketable securities of $100. The interest rate is currently .019 percent per day, and the firm has estimated that the standard deviation of its daily net cash flows is $50. Management has set a lower limit of $1,100 on cash holdings. Calculate the target cash balance and upper limit using the Miller-Orr model. Describe how the system will work.

8. Interpreting Miller-Orr Based on the Miller-Orr model, describe what will happen to the lower limit, the upper limit, and the spread (the distance between the two) if the variation in net cash flow grows. Give an intuitive explanation for why this happens. What happens if the variance drops to zero?

9. Using Miller-Orr The variance of the daily cash flows for the Pele Bicycle Shop is $1.05 million. The opportunity cost to the firm of holding cash is 7 percent per year. What should be the target cash level and the upper limit if the tolerable lower limit has been established as $100,000? The fixed cost of buying and selling securities is $500 per transaction.

10. Using BAT Bates Corporation has determined that its target cash balance if it uses the BAT model is $1,000. The total cash needed for the year is $16,000, and the order cost is $5. What interest rate must Bates be using?

Ross et al.: Fundamentals I VII. Short-Term Financial I 21. Credit and Inventory I I © The McGraw-Hill of Corporate Finance, Sixth Planning and Management Management Companies, 2002

Edition, Alternate Edition

Ross et al.: Fundamentals I VII. Short-Term Financial I 21. Credit and Inventory I I © The McGraw-Hill of Corporate Finance, Sixth Planning and Management Management Companies, 2002

Edition, Alternate Edition

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