Thanks to visit codestin.com
Credit goes to www.scribd.com

Scribd
Upload
996 views10 pages

Advanced Cash Management Models

The Miller-Orr model improves upon Baumol's model by assuming cash balances fluctuate randomly rather than at a constant rate. It estimates an optimal return point and upper limit for cash balances based on the variance of daily cash flows, transaction costs for converting securities to cash, and opportunity costs of holding cash versus securities. The model is demonstrated through an example calculating the return point and upper limit for a company given values for the annual yield, transaction costs, cash flow variance, and minimum cash balance.

Uploaded by

Mohammad Rafiq Dar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
996 views10 pages

Advanced Cash Management Models

The Miller-Orr model improves upon Baumol's model by assuming cash balances fluctuate randomly rather than at a constant rate. It estimates an optimal return point and upper limit for cash balances based on the variance of daily cash flows, transaction costs for converting securities to cash, and opportunity costs of holding cash versus securities. The model is demonstrated through an example calculating the return point and upper limit for a company given values for the annual yield, transaction costs, cash flow variance, and minimum cash balance.

Uploaded by

Mohammad Rafiq Dar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 10

Cash Management III

Cash Management Models


Miller-Orr Model
Miller-Orr Model

• It is an improvement over Baumol’s model.

• On the basis of empirical data, Miller and Orr


argued that the cash balances fluctuate randomly.
It does not follow a constant consumption rate.

• Baumol modes tells how much to be the optimum


transaction size but it does not talk about
treatment of surplus cash balance. When is the
surplus of cash balances?
Cash balance movement
Assumptions
• The changes in cash balances are random. This is applicable
for cash inflows as well as for cash outflows.

• There are opportunities for transaction of marketable


securities.

• Transaction of marketable securities has transaction cost.

• Holding of cash has opportunity cost as well.

• The firms maintain a minimum level of cash balances.


Miller-Orr model
Estimation of Return Point and Upper Limit

3b  2
RP  3  LL
4I
UL  RP  [ 2  ( RP  LL)]
UL  3RP  2 LL
where RP is the return point, b is the fixed cost per transaction
for converting marketable securities into cash,

I is the daily interest rate earned on marketable securities, σ2 is


the variance of daily changes in the expected cash balance,

LL is the lower control limit, and UL is the upper control limit.


An Illustration
• KSK Limited provides the following information about
its cash management system.
• The annual yield on marketable securities is 15 percent.
• The fixed cost of per transaction of marketable
securities transaction is Rs. 2000.
• The standard deviation of the change in daily cash
balance is Rs.5,000.
• The minimum cash balance is Rs.50,000.

• Calculate RP and UL.


Solution
3  2000  5000 2
RP  3  50000
4  0.04167
 44814.05  50000  94814.05
UL  (3  94814.05)  (2  50000)
 184442.10

Lower Limit = 50000

Return Point = 94814.05

Upper Limit = 184442.10


Question for you
• NKM Manufacturer provides the following information
about its cash management system.
• The annual yield on marketable securities is 20 percent.
• The fixed cost of per transaction of marketable
securities transaction is Rs. 1500.
• The standard deviation of the change in daily cash
balance is Rs.4000.
• The minimum cash balance is Rs.40000.

• Calculate RP and UL.


For any query
[email protected]

You might also like