Never Finis Inc needs 500000 in cash per year and has a poli

Never Finis Inc. needs $500,000 in cash per year and has a policy of selling marketable securities every week. The interest rate on marketable securities is 4.5% and it costs $10 to buy or sell securities.

1. What are the trading costs with the current policy?

2. What are the opportunity costs with the current policy?

3. What are the total costs of the current policy?

4. What is the target cash balance according to the BAT model?

5. What is the total cost of the best policy?

Solution

1) Trading costs = 52 weeks * 10 = $               520 2) Value of marketable securities sold evey week = 500000/52 = $           9,615 Interest on average cash balance = (9615/2)*4.5% = $               216 3) Total costs of the current policy = 520.00+216.34 = $               736 4) As per the BAT Model the target balance is given by C = (2*A*T/r)^0.5 where, A = Annual cash requirement, T = Transaction cost, r = interest rate Target cash balance as per BAT = (2*500000*10/0.045)^0.5 = $         14,907 5) Trading cost under the BAT = (500000/14907)*10 = $               335 Opportunity cost = (14907/2)*4.5% = $               335 Total costs under the best policy $               671 Note: Cost of trading can be taken as 500000/14907 rounded off to 34*10 = 340. Total cost would be $675.