Professional Documents
Culture Documents
Prof. b.p.mishra
XIMB
Transaction motive
Firms have sequential transaction
Cash balance by use gets to zero, then
get replenished.
It has two cost =>
(a) Opportunity cost for balance held
(b) Administrative cost for replenishment
In respect to cash holding (a) has direct &
(b) has inverse relationship
3
The firm very well understands the opportunity cost of the cash
held by it.
The opportunity cost is known, constant and does not change
over a period of time.
The transaction cost of the firm is constant and known.
( the transaction cost is the cost incurred whenever the firm
4
converts STS to cash.)
TC = T / C* tc
T = Total amount of cash needed in the
reference period
C = cash balance
tc = Transaction / trading/ administrative cost
Total cost C/2 * r = T / C * tc
=> C = 2 * T * tc /r
5
Example
If tc = Rs 1000
T = Rs 12,00,000
r = 10%
C = ( 2 * T * tc /r)
= (2 * 12,00,000* 1000/ 0.10)
= Rs 1,54,919.33
Opportunity cost is => C /2* r = Rs 1,54,919.33 / 2 * 0.10
= Rs 7745.97
Transaction Cost => TC = T / C* tc
= (Rs 12,00,000 / Rs 1,54,919.33 ) x Rs 1000
= Rs 7745.96
Hence total Cost = Rs 7745.97 + Rs 7745.96
= Rs 15491.93
6
Cash
Cost
Initial cash balance
Total cost
C/2
Opportunity
cost
Average cash
Trading cost
time
C*
Cash
Baumol model
Precautionary motive
To cover adverse shocks or simple
fluctuations around expected cash flow
Finance manager determine optimal, lower
and higher limits
Once limit is reached, firms rebalance
cash balance to target level
A positive relation between optimal cash
balances and variance of daily cash flows.
10
11
Stochastic Model of Miller & Orr:Baumal model fails if the demand for cash is not steady.
If Uncertainty is high, Inventory model can not be used.
If Balances fluctuate randomly, the model can not explain
12
13
Cash
Upper
Target
Return Point
Lower
time
Miller & Orr model
14
15
Z = { ( 3 F 2 ) / 4K } 1/3 + L
Z = Return Cash Point or target Cash balance
F = Transfer Cost from MS TO CASH
= SD of average daily cash balance
K = Holding cost in Percentage
L = Lower cash balance limit set by the firm
16
17
STONE MODEL
Cash
Upper
Inner upper level
Target
Inner Lower level
Lower
time
Miller & Orr model
18
Stone Model
Limitation:Forecast of the Cash flow in the near Future
Can be successfully predicted.
Rely more on the historical cash flow data of the firm
19
20
Speculative motive
Firms wish to profit from positive shocks such as
favorable investment or growth opportunities as
CASH gives them that option.
Option value of cash increases with uncertainty.
Firms with variable cash flows have incentive to
hold more cash.
Uncertainty can be measured from SD of cash
flow or sales.
Recent studies confirmed option value of cash
holding pattern.
21
22
23
Summary
Firm's maintain higher cash balance if-- High level of cash based transaction
They are small in size
Have volatile cash flows
Their MTB ratio is high
Their R&D investment is high
They have weak relationship with financial
system.
24
25
thanks
26