Assuming that ABC Corporation runs two different departments to handle cash outflows and cash inflows,what is the cost to the company of decentralised liquidity management if $100 000 is required to purchase plant and on the same day $175 000 will be received as payment from a customer,if the time period is one month,and the borrowing and lending rates are 15 per cent and 10 per cent,respectively?
A)$1250.00
B)$208.33
C)$625.00
D)$416.67

Question

Quizplus · Accepted Answer

If the liquidity management is centralised, ABC Corporation can use the $100 000 available from the cash inflows department to purchase the plant and pay back the amount borrowed to the cash outflows department at the end of the month, saving on interest costs.
The cost of borrowing $100 000 at 15% for a month is (15/12)%*100 000 = $1250.
The interest earned by lending $175 000 at 10% for a month is (10/12)%*175 000 = $1458.33.
Therefore, the net interest earned is $1458.33 - $1250 = $208.33.
If the liquidity management is decentralised, ABC Corporation will have to borrow $100 000 at 15% to purchase the plant from the cash outflows department and earn $1458.33 by lending $175 000 at 10% to the cash inflows department. Hence, the cost of the decentralised liquidity management is the interest paid on the borrowed amount, which is $1250. Thus, the best choice is D.

Assuming That ABC Corporation Runs Two Different Departments to Handle