Chap019_Appendix.pptVIP

Costs of Holding Cash The BAT Model F = The fixed cost of selling securities to raise cash T = The total amount of new cash needed R = The opportunity cost of holding cash, i.e., the interest rate The BAT Model The BAT Model The BAT Model The Miller-Orr Model The firm allows its cash balance to wander randomly between upper and lower control limits. The Miller-Orr Model Math Given L, which is set by the firm, the Miller-Orr model solves for C* and U Implications of the Miller-Orr Model To use the Miller-Orr model, the manager must do four things: Set the lower control limit for the cash balance. Estimate the standard deviation of daily cash flows. Determine the interest rate. Estimate the trading costs of buying and selling securities. Implications of the Miller-Orr Model The model clarifies the issues of cash management: The optimal cash position, C*, is positively related to trading costs, F, and negatively related to the interest rate R. C* and the average cash balance are positively related to the variability of cash flows. Other Factors Influencing the Target Cash Balance Borrowing Borrowing is likely to be more expensive than selling marketable securities. The need to borrow will depend on management’s desire to hold low cash balances. End of Chapter * McGraw-Hill/Irwin Copyright ? 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Opportunity Costs Trading costs Total cost of holding cash C* Costs in dollars of holding cash Size of cash balance The investment income foregone when holding cash. Trading costs increase when the firm must sell securities to meet cash needs. 19A-* Time C 1 2 3 C 2 – If we start with $C, spend at a constant rate each period and replace our cash with $C when we run out of cash, our average cash balance will be C 2 – The opportunity cost of holding is C 2 – C 2 – ×R 19A-* Time C As we transfer $C each period we incur a trading cost of F. 1 2 3 C 2 – The trading cost is × F – T C –