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  • Baumol

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    Ankit Gupta
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    The document summarizes William J. Baumol's inventory model of cash management. The model treats cash and inventory management problems as the same. It aims to minimize the total costs associated with holding cash, which has an opportunity cost, and converting securities to cash, which has a transaction cost. The model can determine the optimal amount of cash a firm should hold by balancing these two costs. It assumes cash needs can be accurately forecast and occur uniformly over time. The model provides a formula to calculate total costs and determine the optimal amount of securities to convert to cash each period.

    Original Description:

    Description about Baumol Model, Assumptions of baumol, Graphical Representation, Formulna

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    The document summarizes William J. Baumol's inventory model of cash management. The model treats cash and inventory management problems as the same. It aims to minimize the total costs associated with holding cash, which has an opportunity cost, and converting securities to cash, which has a transaction cost. The model can determine the optimal amount of cash a firm should hold by balancing these two costs. It assumes cash needs can be accurately forecast and occur uniformly over time. The model provides a formula to calculate total costs and determine the optimal amount of securities to convert to cash each period.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOCX, PDF, TXT or read online from Scribd
    Flag for inappropriate content
    124 views4 pages

    Baumol

    Uploaded by

    Ankit Gupta
    The document summarizes William J. Baumol's inventory model of cash management. The model treats cash and inventory management problems as the same. It aims to minimize the total costs associated with holding cash, which has an opportunity cost, and converting securities to cash, which has a transaction cost. The model can determine the optimal amount of cash a firm should hold by balancing these two costs. It assumes cash needs can be accurately forecast and occur uniformly over time. The model provides a formula to calculate total costs and determine the optimal amount of securities to convert to cash each period.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOCX, PDF, TXT or read online from Scribd
    Flag for inappropriate content
    of 4

    William J.

    Baumols Inventory Model Of CashManagement

    Submitted To: Prof. Deepeak Ukidave

    Submitted By: Ankit Gupta 12BSP1500 Sec B

    William J. Baumols Inventory Model Of Cash Management


    Baumol model of cash management helps in determining a firm's optimum cash balance under certainty. It is extensively used and highly useful for the purpose of cash management. As per the model, cash and inventory management problems are one and the same. William J. Baumol developed a model (The transactions Demand for Cash: An Inventory Theoretic Approach) which is usually used in Inventory management & cash management. Baumol model of cash management trades off between opportunity cost or carrying cost or holding cost & the transaction cost. As such firm attempts to minimize the sum of the holding cash & the cost of converting marketable securities to cash. The purpose of Baumol Model is to determine the minimum cost amount of cash that a financial manager can obtain by converting securities to cash, considering the cost of conversion and counter-balancing cost of keeping idle cash balances which otherwise could have been invested in marketable securities

    The total cost associated with cash management, according to this model has two elements: (i) Cost of converting marketable securities into cash and (ii) The lost opportunity cost.

    Assumptions:
    The firm is able to forecast its cash needs with certainty. The firms cash payments occur uniformly over a period of time. The opportunity cost of holding cash is known and it does not change over time. The firm will incur same transaction cost whenever it converts securities to cash.

    Graphical Representation:

    Formula:

    TC = I(C/2) + b(T/C)

    C =

    Where, TC = Total Cost (Total Conversion + Holding Cost) I = Interest rate on marketable securities per planning period C = Amount of Securities liquidated per batch T = Estimated cash requirement over the planning period b = Fixed conversion cost

    Example:

    The following data is available for M/s. Impression Ltd. Estimated cash requirement for 6-month planning period is Rs.300000. Fixed conversion cost is Rs.800 per batch. Annual interest rate on marketable securities is 10%. Find how much worth of securities company need to convert.

    Solution:

    C=

    = = 97980

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