BullsNBears, a purveyor of financial databases, estimates it they disburses $440,000 monthly in order to pay bills. The firm's opportunity rate is 5%. The fixed cost of transferring money is $25 per transfer. Based on historical data, the standard deviation of monthly cash flows is $15,000 and the lower cash balance limit is $20,000. For Miller-Orr model questions, assume the interest rate is 0.5% per month.

Using the BAT model, what is the opportunity cost of holding cash?

Question

Using the BAT model, what is the opportunity cost of holding cash?

Quizplus · Accepted Answer

The opportunity cost of holding cash using the Baumol (BAT) model is calculated as follows: $OC = \frac{1}{2} \times T \times i$, where $T$ is the total disbursement (or transaction amount) and $i$ is the opportunity cost rate (interest rate). Given that $T = $440,000$ and $i = 5\%$ or $0.05$ annually (which needs to be converted to a monthly rate if we assume the calculation is meant for a monthly period, but since no specific instruction on converting the annual rate to monthly, we'll use the annual rate directly), the calculation is $OC = \frac{1}{2} \times 440,000 \times 0.05 = $11,000$ annually. However, since the options provided do not match this calculation directly and assuming a monthly perspective might have been intended without direct conversion of rates, we'll adjust our approach based on the options given.Given the misunderstanding in the initial calculation and the options provided, it seems there might have been a misinterpretation of the calculation method or the options do not directly correspond to the standard BAT model calculation. The correct approach for a monthly calculation with an annual rate directly applied seems not to be reflected in the options, suggesting a possible need for clarification or a mistake in the calculation process. Revisiting the calculation with a focus on the options provided and considering the possibility of a monthly calculation with an annual rate (without conversion), or an error in the initial explanation, it's important to note that the Baumol model might not directly apply to the options given without further assumptions or adjustments. The initial explanation aimed to apply the BAT model formula directly but did not align with the provided options, indicating a potential misunderstanding in the application of the model or the need for additional information to accurately select an option based on the Baumol model's standard calculation method.

BullsNBears, a Purveyor of Financial Databases, Estimates It They Disburses