![]() Miller and Daniel Orr (A Model of the Demand for Money) expanded on the Baumol model and developed Stochastic Model for firms with uncertain cash inflows and cash outflows.The Miller and Orr (MO) model provides two control limits-the upper control limit and the lower control limit along-with a return point as shown in the figure below:When the cash balance touches the upper control limit (h), markable securities are purchased to the extent of hz to return back to the normal cash balance of z. The Miller and Orr model overcomes the shortcomings of Baumol model. ![]() The cash flows of a firm are neither uniform nor certain. This usually does not happen in practice. Miller and Orr Model:Baumol’s model is based on the basic assumption that the size and timing of cash flows are known with certainty. Also show that the economic lot size can be obtained by the Baumol Model.Cash Management Model # 2. You are required to prepare a table indicating which lot size will have to be sold by the company. The company can earn 5% annual yield on its securities. Cost of conversion of marketable securities per lot is Rs 1,000. The figure below shows the optimum cash balance.Illustration 1:The annual cash requirement of A Ltd. ![]() The cost of converting marketable securities into cash etc.) The optimal cash balance is reached at a point where the total cost is the minimum. ![]() Baumol developed a model (The Transactions Demand for Cash: An Inventory Theoretic Approach) which is usually used in inventory management but has its application in determining the optimal cash balance also.īaumol found similarities between inventory management and cash management.As Economic Order Quantity (EOQ) in inventory management involves tradeoff between carrying costs and ordering cost, the optimal cash balance is the tradeoff between opportunity cost or cost of borrowing or holding cash and the transaction cost (i.e.
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