[Biff-1955-Tannen]

A company has a 10% cost of borrowing and incurs fixed costs of $500 for obtaining a loan. It has stable, predictable cash flows and the estimated total amount of net new cash needed for transactions for the year is $175,000. The company does not hold safety stocks of cash.

If the average cash balance for the company during the year is $20,916.50, then the opportunity cost of holding cash for the year will be:

the answer is 2,091.65. I understand how they got the answer, but I don’t get what this question is even asking.

EDIT: So are we supposed to assume that by holding cash they are forgoing 10% interest they could earn by investing?

AUD 93 Jan 16
BEC 83 Feb 16
FAR 83 Apr 16
REG 84 May 16

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[monikernc]

What you said, or they could reduce the amount of interest paid by reducing their average cash balance.

FAR 7/25/15 76!
AUD 10/30/15 93
BEC 2/27/16 82
REG 5/23/16 88!
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[r]

i feel the same way. I have no clue what the question is asking. about 15 days till my test. im freaking out

[fragchild]

It's misdirection and commonly used approach in the exams. I tend to read and understand the question first before reading the summary information. The question clearly asks what the opportunity cost of holding the cash for the year. As such, the main information is the 10% cost of borrowing and average cash balance during the year.

They could save 10% by reducing the loan balance by $20k, or possibly investing the $20k at 10%.

[Author]

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