Page 486 - Microsoft Word - 00 ACCA F9 IWB prelims 2017.docx

Chapter 20

Question 4

Baumol model

A company is undertaking a large investment which will require cash next year
of $500,000 spread evenly throughout the year. At the moment it holds most of
its money in a short-term deposit account. In order to pay for the investment it
intends to move this money from the deposit account into the current account.

If the transaction fee every time money is transferred between the accounts is
$29.50 and the deposit account earns interest of 2% per year, calculate how
frequently (in weeks) the company should transfer cash from the deposit
account and how much cash should be transferred each time.

Co = $29.50

D = $500,000

Ch = $0.02

Q = √(2 × $29.50 × $500,000/$0.02) = $38,406 should be transferred each time.

To transfer a total of $500,000 during the year this will require ($500,000/
$38,406) 13 transactions, which equates to (52/13) every 4 weeks.

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