The correct answer is: D. Demand for cash is variable.
The Miller-Orr model is a cash management model that helps firms determine how much cash to hold on hand. The model is based on the assumption that the demand for cash is variable and that firms can trade off the costs of holding too much cash (opportunity cost) and the costs of holding too little cash (transaction costs).
The model works by setting upper and lower limits on the amount of cash that a firm should hold. The upper limit is the maximum amount of cash that the firm should hold, and the lower limit is the minimum amount of cash that the firm should hold. The firm then sets up a system to monitor its cash balance and to make transfers between its cash account and its investment account when the balance falls below the lower limit or rises above the upper limit.
The Miller-Orr model is a useful tool for firms that need to manage their cash effectively. The model can help firms to reduce their costs and to improve their liquidity.
Here is a brief explanation of each option:
- Option A: Demand for cash is steady. This is not a good situation for using the Miller-Orr model because the model is designed for firms with variable cash demand. If the demand for cash is steady, the firm can simply set a target cash balance and hold that amount of cash on hand. There is no need to use the Miller-Orr model to track the cash balance and make transfers between the cash account and the investment account.
- Option B: Demand for cash is not steady. This is the situation that the Miller-Orr model is designed for. The model helps firms to manage their cash effectively when the demand for cash is variable.
- Option C: Carry cost and transaction cost are to be kept at minimum. The Miller-Orr model can help firms to reduce their costs, including carry cost and transaction cost. However, the model is not designed specifically to minimize these costs.
- Option D: Demand for cash is variable. This is the correct answer. The Miller-Orr model is a cash management model that helps firms determine how much cash to hold on hand. The model is based on the assumption that the demand for cash is variable and that firms can trade off the costs of holding too much cash (opportunity cost) and the costs of holding too little cash (transaction costs).