Happy Feet would like to maintain their cash account at a minimum level of $75,000, but expects the standard deviation in net daily cash flows to be $5,000; the effective annual rate on marketable securities to be 7 percent per year; and the trading cost per sale or purchase of marketable securities to be $150 per transaction. What will be their optimal upper cash limit?
A) $80,000.00
B) $99,755.64
C) $76,593.42
D) $149,266.92

Question

Quizplus · Accepted Answer

The optimal upper cash limit can be calculated using the Miller-Orr model. The formula for the upper limit is: Upper Limit = Lower Limit + 3 * (Transaction Cost * Variance of Cash Flows / Interest Rate)^(1/3). Plugging in the values: Lower Limit = $75,000, Transaction Cost = $150, Variance = $5,000^2, Interest Rate = 0.07, we get the upper limit as approximately $149,266.92.

Happy Feet Would Like to Maintain Their Cash Account at a Minimum