Marketable Securities

Management
Submitted By:
Rizalyn Vergara
Phoebe Jean Mahusay
Ruel Villanueva

I. Optimum cash balance, liquid industries forecast cash outlays of P48 million
for its next fiscal year. A financial analyst for the company has estimated the
conversion cost of converting marketable securities to cash to be P900 per
conversion transactions and the annual operating cost of holding cash instead

of marketable securities to be 8%. Presently, the company converts cash to

marketable securities and vice versa on a monthly basis.
Problems: Using the Baumol Model
1. Optimal cash conversion amount?
2. Average cash balance?
3. The number of conversion to be made during the year?
4. The total cash cost?
5. The net advantage if the company follows the optimal cash
conversion model.
Solutions:
1. Optimal Cash Balance =
=

(2 x AD x CPT) / CCR
(2 x P48 million x P900) / 8%

= P 1, 039, 230
2. Ave. cash Balance = P 1, 039, 230 / 2
= P 519, 615
3. Number of Conversions = P48 million / P 1, 039, 230
= 46.18804 times

4. Transaction Costs (46.18804 x 900)

Opportunity Costs (P 519, 615 x 8%)
Total Cash Costs

5. Transaction Costs (12 x P 900)

P 41, 569
41, 569
P 83, 138

P 10, 800

Opportunity Costs (P48 million / 12) x 8%

320, 000

Total cash Costs Monthly Basis

P 330, 800

Total Cash Costs Optimal Basis

83, 138

Adv. of the Optimal Cash Conversion Model

P 247, 662

II. Optimum cash balance. DEF Corporation uses the Miller-Orr model to
manage its cash account. Recently, someone asked how sensitive the
solution for the return point and upper limit is to changes the conversion cost,
the variance of daily net cash flows and the daily opportunity cost rate. The

values that are currently used are a P50 conversion cost, a daily P2 million net
cash flow variance and a 10% annual opportunity cost.
Problems:
6. The return point.
7. The upper limit using the current values.
Solutions:
6. The return point =
2 x Cost per transactions x Variance of daily net cash flows
4 x daily opportunity cost

(2 x P50 x P2, 000,000) / (4/ (.08.360))

P200 million / (4 x 0.000222)

P474, 580

7. Upper limit = 3 x Return Point

= 3 x P 474, 580
= P1, 423,740

III. Effective interest rate. EIR Corporation wants to raise P 5 million through
short term borrowing. The company gathered data from several banks and
financing institutions and assembled the following:
Lending institution A

Amount to be
borrowed
Nominal interest
rate

P5M

P5M

P5M

P5M

P5M

10%

12%
disc.

11.5%

14%

15%,
discounted

Compensating
balance
Average deposit
balance even if the
loan is not granted

none

5%

4%

14%

15%

none

none

none

none

P200,000

Term of loan

1 yr.

1yr.

1yr.

1yr

1yr.

Interest earned by
the compensating
balance

n/a

6%

6%

6%

6%

8. Required: For each of the terms of the loan offered by the lending
institutions, calculate the effective interest rate

Interest
payments
-Interest
income from
compensatin

P500000

P600000

P575000

700000

7500000

g balance

15000

12000

18000

Net financing
charges
Principal
-Increase in
compensatin
g balance
-Discounted
interest
Net proceeds
Effective
interest rate

500,000

585,000

563,000

700,000

732,000

5,000,000
0

5,000,000
(250,000)

5,000,000
(200,000)

5,000,000
(200,000)

5,000,000
(300,000)
(750,000)

(600,000)

5,000,000

4,150,000

4,800,000

5,000,000

3,950,000

10%

14.10%

11.73%

14.%

18.53%

Interest payment = (principal x Nominal interest rate )

Interest income from compensating balance = increase in compensating
balance x interest rate
Effective interest rate = net financing charges / net proceeds

IV. Effective interest rate, continuing basis. A local bank has just approved a
90- day, P200, 000, 12% per annum line of credit to VJ Company. VJ plans to
regularly avail of the credit line throughout the year. Determine the effective
interest rate on continuing basis.

Solution guide:
9.)Effective interest rate
=P24,000/(P200,000-P24,000)=13.64
10.) No. of periods
=360 days/90 days = 4
11.) Periodic effective interest rate
=13.64%/4 = 3.41%
12.) Annual effective interest rate
=[(1+0.0341)4- 1] = 18.25%

A. Tulips Company has daily cash receipts of P85,000. A recent analysis of

its collection indicated that customers payments were in the mail an
average of 2.5 days. Once received, the payments are processed in 1.5
days. After payments are deposited, it takes an average of three days
for these receipts to clear the banking system.
13. How much collection float (in days) does the firm currently have?
a. P 456,678
b. P 587,845
c. P 595,000
d. P 400,000
14. If the firms opportunity cost is 11%, would it be economically
advisable for the firm to pay at an annual fee of P16,500 to reduce
collection float by four days?
a. 20,900
b, 19,100
c. 25,000
d. 18,700

B. A firm that has an opportunity cost of 9% is contemplating installation of

a lockbox system at an annual cost of P90,000. The system is expected
to reduce mailing time by 2.5 days and reduce clearing time by 1.5
days. The firm collects P300,000 per day.
15..

Determine the net benefit (cost) of installing the lockbox system.

a. 19,000
b. 20,000
c. 17,000
d. 18,000

C. Mills Corporation sells to national market and bills all credit customers
from the Makati Office. Using a continuous billing system, the firm has a
collection of P1.2 million per day. Under consideration is a concentration
banking system that would require customers to mail payments to the
nearest regional office to be deposited in local banks. Mills estimates
that the collection period for accounts will be shortened by an average
of 2.5 days under this system. The firm also estimates that annual
service charges and administrative costs of P300,000 will result from
the proposed system. The firm can earn 14% on equal-risk investments.
16. . How much cash will be made available for other uses if the firm accepts
the proposed concentration banking system?
a. 3 million

b. 2 million
c. 1 million
d. 4 million
17.

What savings will the firm realize on the 2.5 day reduction in the

collection period?
a. 320,000
b. 420,000
c. 390,000
d. 220,000
18. The net benefit (cost) of the concentration banking.
a. 120,000
b. 100,000
c. 180,000
d. 150,000
D. South Star Corporation just received a check in the amount of P800,000
from a customer in Gensan. If the firm processes the check in the
normal manner, the funds will become availbalein 7 days. To speed up
the process, the firm could send an employee to the bank in Gensan on
which the check is drawn to present it for payment. Such action will

cause the funds to become available after 3 days. The cost of the direct
send is P800 and the firm can earn 11% on these funds.
19. Calculate the net benefit of this system.
a. 154
b. 164
c. 165
d. 166
E. A large Iligan firm has annual cash disbursements of P360 million made
continuously over the year. Although annual service and administrative
costs would increase by P100,000, the firm is considering writing all
disbursement checks on a small bank in Bukidnon. The firm estimates
that this will allow an additional 1.5 days of cash usage. The firm earns
a return on the other equally risky investment of 12%.
20. Determine the net advantage (disadvantage) of using the technique of
cash disbursement.
a. 75,000
b. 70,000
c. 65,000
d. 60,000

SOLUTIONS:
13. Cash collection float = Average daily collection x Total float in days
= P85,000 x (2.5 days + 1.5 days + 3 days)
= P85,000 x 7 days
= P595,000C
14. Potential income (P85,000 x 4 x 11%)
Annual cost of reducing the float
Net advantage of reducing the float by 4 days

P37,400
(16,500)
P20,900A

15. Benefit of using the lockbox system (P300,000 x 4 days x 9%)

P108,000
Cost of using the lockbox system
( 90,000 )
Net benefit of using the lockbox system
P 18,000D
16. Cash made available using the concentration banking
= P1.2 million x 2.5 days
= P 3 millionA
17. Savings from reducing the collection days
= P 3 million x 14%
= P 420,000B
18. Saving from reducing the collection days
Annual service charge from using the concentration banking
Net benefit of using the concentration banking

P 420,000
300,000
P 120,000A

19. Benefit from accelerating collection (P800,000 x 4/365 days x 11%)

Cost of accelerating collection through direct sends
Net benefit from using the direct send system

P 964
800
P 164B

20. Benefit from delaying payment (P360 million/360 days x 1.5 days x 11%) P 165,000
Cost of delaying payment
100,000
Net benefit of delaying payment through controlled disbursing
P 65,000C