The correct answer is C, that the optimum amount of short-term investments to convert into cash in each transaction is $54,772. Many candidates chose answer B, while a minority of candidates chose answers A or D, rather than answer C.
It should be noted that the Baumol model applies the economic order quantity (EOQ) model to cash and that the EOQ formula is in the formulae sheet. The Baumol model essentially treats cash deposits as inventory, redefining the EOQ variables to deal with cash deposits.
Demand for cash is $150,000 per year and the fixed cost of getting cash from short-term investments (the ordering cost) is $400 per transaction.
The penalty or opportunity cost of holding cash rather than short-term investments (the holding cost) is the difference between the interest rates on the two items, namely 4% per year.
The optimum amount of short-term investments to convert into cash in each transaction is therefore (2 x 400 x 150,000/ 0·04)0·5 = $54,772.