Miller-Orr Model? -with respect to Financial Management.

Agree With the answer given by Ms. SreeDevi Sunilkumar 

Miller -Orr Model is a Cash management Model.

Cash management models are aimed at minimising the total costs associated with movements between a company's current account (very liquid but not earning interest) and their short-term investments (less liquid but earning interest).

The models are devised to answer the questions:

• at what point should funds be moved?
• how much should be moved in one go?

The Baumol cash management model

Baumol noted that cash balances are very similar to inventory levels, and developed a model based on the economic order quantity(EOQ). Assumptions:

 cash use is steady and predictable

• cash inflows are known and regular
• day-to-day cash needs are funded from current account
• buffer cash is held in short-term investments.

The Miller-Orr model is used for setting the target cash balance for a company.

The diagram below shows how the model works over time.

• The model sets higher and lower control limits, H and L, respectively, and a target cash balance, Z.
• When the cash balance reaches H, then (H-Z) dollars are transferred from cash to marketable securities, i.e. the firm buys (H-Z) dollars of securities.
• Similarly when the cash balance hits L, then (Z-L) dollars are transferred from marketable securities to cash.

The lower limit, L is set by management depending upon how much risk of a cash shortfall the firm is willing to accept, and this, in turn, depends both on access to borrowings and on the consequences of a cash shortfall.

The formulae for the Miller-Orr model are:

Return point = Lower limit + (1/3 × spread)

Spread =3 [ (3/4 × Transaction cost × Variance of cash flows) ÷ Interest rate ] 1/3

Note: variance and interest rates should be expressed in daily terms. Variance = standard deviation squared. 

The Miller-Orr model is used for setting the target cash balance for a company.