Ch027 - Chapter 27: Cash Management 27.1 Firms need to hold...

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Unformatted text preview: Chapter 27: Cash Management 27.1 Firms need to hold cash to: a. Satisfy the transaction needs. For example, cash is collected from sales and new financing and disbursed as wages, salaries, trade debts, taxes and dividends. b. Maintain compensating balances. A minimum required compensating balance at banks providing credit service to the firm may impose a lower limit on the level of cash a firm holds. 27.2 a. Decrease. Examine the Baumol model. As the interest rate (k) increases, the optimal cash balance must also decrease. b. Increase. Examine the Baumol model. As brokerage costs (F, the per transaction costs) rise, the optimal balance increases. c. Decrease. Clearly, if the bank lowers its compensating balance requirement, a firm will not be required to hold as much of its assets as cash (assuming that the firm's cash need for the transaction motive is below the compensating balance requirement). d. Decrease. If the cost of borrowing falls, a firm need not hold as much of its assets as cash because the cost of running short (borrowing to fill cash needs) is lower. e. Increase. As a firms credit rating falls, its cost to borrow increases. Thus, the firm cannot as easily afford to run short of cash and its cash balance must be higher. f. Increase. Introduction of direct banking fees would increase the fixed costs associated with holding cash. As fixed costs rise, the optimal balance must also rise. 27.3 In order to determine weekly earnings (sometimes the word "return" is used to mean dollar amounts) on the cash balances, first find the weekly interest rate .12 .002308 52 r = = and apply this to each of the weekly amounts: Week Avg Cash Balance $ Earned 1 24,000 55.39 2 34,000 78.47 3 10,000 23.08 4 15,000 34.62 Avg monthly 83,000 191.56 Average annual earnings = 191.56 Average annual earnings = 191....
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This note was uploaded on 03/29/2010 for the course ECON 134a taught by Professor Lim during the Spring '08 term at UCSB.

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Ch027 - Chapter 27: Cash Management 27.1 Firms need to hold...

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