## Presentation on theme: "© 2003 The McGraw-Hill Companies, Inc. All rights reserved. Cash and Liquidity Management - Appendix Chapter Twenty A."— Presentation transcript:

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved. 20A.1 Target Cash Balances Target cash balance – desired cash level determined by trade-off between carrying costs and shortage costs Flexible policy - If a firm maintains a marketable securities account, the primary shortage cost is the trading cost from buying and selling securities Restrictive policy – Generally borrow short- term, so the shortage costs will be the fees and interest associated with arranging a loan

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved. 20A.3 BAT Model Assumptions –Cash is spent at the same rate every day –Cash expenditures are known with certainty Optimal cash balance is where opportunity cost of holding cash = trading cost –Opportunity cost = (C/2)*R –Trading cost = (T/C)*F –Total cost = (C/2)*R + (T/C)*F

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved. 20A.4 Example: BAT Model Your firm will have \$5 million in cash expenditures over the next year. The interest rate is 4% and the fixed trading cost is \$25 per transaction. –What is the optimal cash balance? –What is the average cash balance? –What is the opportunity cost? –What is the shortage cost? –What is the total cost?

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc. All rights reserved. 20A.5 Miller-Orr Model Model for cash inflows and outflows that fluctuate randomly Define an upper limit, a lower limit and a target balance –Management sets lower limit, L –C* = L + [(3/4)F 2 /R] 1/3 (target balance) –U* = 3C* - 2L(upper limit) –Average cash balance = (4C* - L)/3