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Question 3: Miller-Orr Model

You are a financial analyst for a manufacturing company that wants to implement the Miller-Orr Model to manage its cash balances. The company has identified a need for an effective cash management strategy to avoid running into liquidity issues.

a) Explain the objectives and principles of the Miller-Orr Model and how it helps organizations set upper and lower control limits for cash balances.

b) The minimum cash balances of K2,000,000 is required at Liquid Express Solutions Limited and transferring money to and from the bank costs K5,000 per transaction. Inspections of daily cash flows over the past years(from Experience) suggests that the standard deviation of is 300,000 per day and hence the variance of 9,00,000,000.The interest rate is 0.1% per day. Calculate, the Spread between the Upper and the Lower Limit, the Upper Limit and the return point.

c) Calculate the target cash balance, upper control limit (UCL), and lower control limit (LCL) for the company based on the given parameters: the company's daily cash flow volatility is K500,000, the required average cash balance is K3,000,000, and the Z-value for a 95% confidence level is 1.65.

d) Describe the actions the company should take if its actual cash balance exceeds the UCL or falls below the LCL. How can the Miller-Orr Model assist the company in maintaining appropriate cash levels and managing liquidity efficiently?

Question 2: Baumol Model

You are the finance manager of a retail company that frequently holds cash to cover operational expenses and payments to suppliers. The company is considering adopting the Baumol Model to optimize its cash management.

a. Explain the key assumptions of the Baumol Model and how it can help the company determine its optimal cash balance.

b. Calculate the company's optimal cash balance using the Baumol Model,the number of transactions that will arise each year, the cost of making those transactions per year and the opportunity cost of holding cash per year based on the given parameters: the annual cash usage for operational expenses is K1,000,000, the fixed cost of transferring funds from investments to cash is K500, and the opportunity cost of holding cash is 5%.

c. Discuss the implications of the calculated optimal cash balance on the company's cash management strategy. How can the Baumol Model assist the company in minimizing cash-related costs?