The UMUC bank has a local subsidiary which requires 75000 ca

The UMUC bank has a local subsidiary which requires $75,000 cash every month. It uses safe armored trucks service for the cash delivery. The service company charges $2,000 for each delivery. In order to send cash to its subsidiary, the bank has to liquidate part of its securities portfolio which generates 15% annual return. How many armored truck service trips per month should it order? (Hint: The annual rate of return in this question is given as 12 * actual monthly rate of return)

Solution

Answer:

The service company charges for each delivery = $2,000

Monthly Amount required by local subsidiary = $75,000

Opportunity Cost of liquidating:

Annual cost = 15%

Hence per month cost = 15%/12

Let us assume entire amount is liquidated once and delivered once in a month:

Opportunity cost (cost of liquidating security for entire amount of $75,000 at one go) = $75,000 * 15%/12 = $937.50

Total cost = Opportunity cost + armored trucks service for one delivery per month

= $937.50 + $2000 = $2937.50

Each increase in delivery per month would cost UMUC bank an additional $2,000 but saving in opportunity cost (in terms of returns lost) would be much less than $2,000 since total opportunity cost of liquidating entire amount of $75,000 once in a month is $937.50)

Hence, armored truck service trips per month it should order is once a month.