Question

1. Halliday Inc. receives a $2 million payment once a year. Of this amount, $750,000 is needed for cash payments made during the next year. Each time Halliday deposits money in its account, a charge of $6.95 is assessed to cover clerical costs. If Halliday can hold marketable securities that yield 5%, and then convert these securities to cash at a cost of only the $6.95 deposit charge, what is the total cost for one year of holding the minimum cost cash balance according to the Baumol model? Enter your answer rounded to two decimal places. Do not enter $ or comma in the answer box. For example, if your answer is $12,300.456 then enter as 12300.46 in the answer box.

2. Use the data from problem 4 and consider the following new information. Interest rates in the market have declined so that marketable securities now yield only 1%. In addition, Halliday Inc.'s bank has raised the deposit charge from $7.95 to $9.95. How will these two changes affect the optimal cash amount C* from the Baumol Model?

Group of answer choices

C* will increase.

C* will decrease.

C* will stay the same.

Indeterminate without more information.

C* = $750,000 with only one transfer per year to minimize total cash costs of holding costs and transactions costs.

Answer 1

Part 1. Optimum cash balance (C*) = 2 * Fixed cost * total cash / Yeild rate

= 2 * 6.95 * 750000 / 2%

= 10425000/0.02

= 521250000

= $22830.90

Total Cost = Fixed cost * total cash / Optimum cash

= 6,95 * 750000 / 22830.90

= $228.30

Part 2. For this yeild will be substituted for 1% and cost will be substituted for $9.95

Optimum cash balance (C*) = 2 * Fixed cost * total cash / Yeild rate

= 2 * 9.95 * 750000 / 1%

= 14925000/0.01

= 1492500000

= $38632.89

Ans : C* will Increase ( It increased from $22830.90 to $38632.89)