Question

Other things held constant, if a firm holds cash balances in excess of their optimal level in a non-interest bearing account, this will tend to lower the forms?

What is the future value of a 5 year annuity with annual payments of $200, evaluated at a 15% interest rate?

Answer 1

First question: Holding cash in excess of optimal level in a non-interest bearing account would lower the company's Total Asset Turnover and Return of Equity.

• As Cash and cash equivalents are Current Assets, it directly impacts the Total Asset Turnover since it increases the denominator of Total Asset Turnover, which is Total Assets, without yielding any benefit for the numerator, which is Sales. If the company invests the excess cash in the firm to generate more Sales, it would increase the Total Assets Turnover, however, it being there idle decreases the Total Asset Turnover. Note: Total Assets Turnover formula = Sales / Total Assets
• As Total Assets increases due to cash providing no return to the firm, it also increases the firm's Shareholders equity (Equity = Assets - Liabilities) as increase in Assets leads to increase in Equity which is the denominator in Return on Equity. It increases equity without providing an interest income which could have increased company's Net Income which is the numerator. If the company had generated interest income or invested the excess cash in a project, then it would have led to increase in Return on Equity.

Second Question:

Annual Payments = $200 | Interest rate = 15% | Time = 5 years

We need to calculate the Future Value of the annuity. Hence, we will use FV of Annuity formula.

FV of Annuity formula = (PMT / R)*((1+R)^T - 1)

Putting values for their respective parameters, we can solve the formula for FV of Annuity.

FV of Annuity = (200 / 15%)*((1+15%)⁵ - 1)

FV of Annuity = 1333.3333 * 1.011357

FV of Annuity = $1,348.48 or 1,348.5

Hence, FV of the 5 year annuity is $1,348.48 or 1,348.5.