Question

XYZ Ltd has an average cash balance of sh. 2,000. Total cash needed for the year is sh. 200,000. The interest rate is 5% p.a. and the costs of replenishing the cash is sh. 80 each time. Calculate: a) The opportunity costs b) Transaction costs c) Total costs d) Comment on the company’s cash management strategy

Answer 1

a)
Opportunity cost = Daily cash balance * Interest rate
= 2,000 * 5%
= 100

Opportunity cost = 100.

b)
Trading cost = (Total cash needed * Replenishing cost) / (Average daily balance * 2)
= (200,000 * 80) / (2,000 * 2)
= 16,000,000 / 4,000
= 4,000

Trading cost = 4,000.

c)
Total cost = Opportunity cost + Trading cost
= 100 + 4,000
= 4,100.

Total cost = 4,100.

d)
Company's cash management strategy is bad. It has a cash balance of 2,000 with total cost of 4,100.