The Eastern Trading Company of Singapore presently follows a decentralized system of cash management where it and its affiliates each maintain their own transaction and precautionary cash balances. Eastern Trading believes that it and its affiliates' cash needs are normally distributed and independent from one another. It is corporate policy to maintain two and one-half standard deviations of cash as precautionary holdings. At this level of safety there is a 99.37 percent chance that each affiliate will have enough cash holdings to cover transactions.
A new MBA hired by the company claims that the investment in precautionary cash balances is needlessly large and can be reduced substantially if the firm converts to a centralized cash management system. Use the projected information for the current month, which is presented below, to determine the amount of cash Eastern Trading needs to hold in precautionary balances under its current decentralized system and the level of precautionary cash it would need to hold under a centralized system. Was the new MBA a good hire?
