The Norris Company is trying to determine its optimal average cash balance.
The firm has determined that it will need $5,000,000 net new cash during the coming year. The fixed transaction cost of converting securities to cash is $50, and the firm earns 10 percent on its marketable securities investments.
-What will be the total cost to Norris of maintaining the optimal average cash balance, as determined by the Baumol model?
A) $35,356
B) $ 7,071
C) $18,493
D) $70,711

Question

Quizplus · Accepted Answer

Using the Baumol model, the optimal average cash balance can be calculated as:
√((2 x $5,000,000 x $50)/0.1) = $50,000
The total cost of maintaining this balance would be:
($5,000,000/$50,000) x $50 + (0.1/2) x $50,000 = $7,071. Therefore, the best choice is B.

The Norris Company Is Trying to Determine Its Optimal Average