Q. Explain about Types of costs?
Thus two types of costs are involved in keeping cash balance in a business-
(i) Opportunity Cost
(ii) Transaction Cost
When cash balance increases, opportunity cost increases but transaction cost decreases. Alternatively when cash balance is less signifies opportunity cost decreases but transaction cost increases.
Optimal cash balance is that level of cash at which the opportunity cost and transaction cost becomes equal. In other sense total cost of keeping cash balance will be minimum if both of its components that are opportunity cost and transaction cost are equal.
Assumptions: - The Baumol Model is on the basis of following assumptions:-
(i) The cash requirements of the firm are known with certainty
(ii) The cash disbursements of the firm takes place uniformly over a period of time and is known with certainty
(iii)The opportunity cost of holding cash is recognized and it remains constant.
(iv) The transaction rate of converting securities into cash is known as well as remains constant.