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    Millar Orr Model

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    Mohammad Rafiq Dar
    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.

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    Millar Orr Model

    Uploaded by

    Mohammad Rafiq Dar
    272 views10 pages
    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.

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    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.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    272 views10 pages

    Millar Orr Model

    Uploaded by

    Mohammad Rafiq Dar
    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.

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    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
    nagendrainsearch@gmail.com

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