Your ﬁrm needs $135,000 a week to pay bills. The standard deviation of the weekly disbursements is $12,000. The ﬁrm has established a lower cash balance limit of $60,000. The applicable interest
Rate is 5 percent and the ﬁxed cost of transferring funds is $45. What is the opportunity cost of
Holding cash?

Question

Quizplus · Accepted Answer

The opportunity cost of holding cash is the interest that could have been earned on the cash if it had been invested instead. In this case, the firm needs $135,000 a week to pay bills, and the standard deviation of the weekly disbursements is $12,000. The firm has established a lower cash balance limit of $60,000. The applicable interest rate is 5 percent, and the fixed cost of transferring funds is $45.The opportunity cost of holding cash is calculated as follows:Opportunity cost = (Average cash balance - Lower cash balance limit) * Interest rateAverage cash balance = (Upper cash balance limit + Lower cash balance limit) / 2= ($135,000 + $60,000) / 2= $97,500Opportunity cost = ($97,500 - $60,000) * 0.05= $3,750However, the firm also incurs a fixed cost of $45 each time it transfers funds. Therefore, the total opportunity cost of holding cash is:Total opportunity cost = Opportunity cost + Fixed cost of transferring funds= $3,750 + $45= $3,795Therefore, the opportunity cost of holding cash is $3,795.

Your ﬁRm Needs $135,000 a Week to Pay Bills