Baumol's Model - Optimal Cash Balance

An application of the EOQ is the Baumol's model which is inventory model to cash management. Its statements are as:

1. The firm employs cash at a steady predictable rate
2. The cash outflows from operations happens at a steady rate also
3. The cash total outflows also happen at a steady rate.

Beneath these assumptions the following model can be stated:

Whereas: C* is the optimal amount of cash to be raised via borrowing or via selling marketable securities.

               b is the fixed cost of borrowing or of creation a securities trade

               T is the net annual cash necessities

                i is the chance cost of holding cash or like equals the interest rate at the cost of borrowing or marketable securities

The whole cost of holding the cash balance is equivalent to carrying or holding cost plus transaction costs and is specified via the following formulae as:

TC = ½ (Ci) + T/c (b)