Question

The annual cash requirement for a firm is $1,000,000. The cost for each security transaction is $20 and current short-term return is 5 percent. Using Baumol's model estimate the initial cash balance.

$21,285.16

$28,284.27

$11,152.16

$16,814.28

Answer 1

Baumol's model = ( 2 * A * F / O) ^1/2

Where A = annual cash requirement = 1,000,000

F = Fixed cost = 20

O = Opportunity cost = 5% = 0.05

Applying the values:

( 2 * A * F / O) ^1/2

⁼ ( 2 *1,000,000 * 20 / 0.05) ^1/2

= 28284.27

Option $28,284.27