Chapter 28

Chapter 28 - Chapter 28 - Cash Management Basic objective...

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Basic objective of cash management is to keep the investment in cash as low as possible while still operating the firm’s activities efficiently and effectively 3 steps o determining the appropriate target cash balance → trade-off between the cost and benefit of liquidity o collecting and disbursing cash efficiently→ collect early and pay late o investing excess cash in marketable securities 28.1 Reasons for holding Cash Cash management is concerned with how to minimize cash balances by collecting and disbursing cash effectively Two reasons for holding cash Transaction motive - Collections and disbursements are not perfectly synchronized cash holding serves as a buffer o To obtain cash, company must sell marketable securities or borrow which involves trading costs Compensating Balances - impose lower limit on the level of cash a firm holds → the cost of holding cash is the opportunity cost 28.2 Determining the target cash balance The target cash balance involves the trade off between the opportunity cost of holding too much cash and the trading costs of holding too little. Figure 28.1.: The Baumol Model Example: Figure 28.2: Then: C= Initial cash balance F= The fixed cost of selling securities to replenish cash T= The total amount of new cash needed for transactions purposes over the relevant planning period K= Opportunity cost of holding cash; interest rate on marketable security. Opportunity cost = (C/2) * K
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Chapter 28 - Chapter 28 - Cash Management Basic objective...

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