Brewing beer has always been the core business of Anheuser-Busch Companies, Inc. The industry leader since 1957, Anheuser-Busch currently owns 45% of the domestic beer market. This represents annual sales of 88.5 million barrels of beer. Market share has grown so much that Anheuser-Busch now has a larger portion of the market than their next four largest competitors combined.

International sales are no different. Anheuser-Busch International remains the leading exporter of beer from the United States with sales in more than 65 countries.

Microbreweries, or microbrews for short, have been gaining attention in recent years. Microbrews are defined as breweries that produce less than 15,000 barrels a year. The strength of microbrews is their philosophy that beer should be of the highest quality. Microbrews are only made with malted barley, hops, water, and yeast, the only four ingredients found in the purist German beers. Mass bottled beers usually add rice and corn to minimize costs. The drawback of microbrews is their cost. The more expensive ingredients make microbrews cost an average of 60% more than mass bottled beers.

Beer is not like wine which gets better with age. Instead, it is a food that should be consumed as soon after production as possible. As such, beer pubs or microbrews that produce beer on the premises, are the hottest new trend with an average of four new pubs popping up every week. Sales have grown an average of 40% per year. This figure is extremely impressive when one considers that the beer market as a whole is shrinking. Even with this success, microbrew sales represent only two percent of the $50 billion dollar beer market.

In their relentless pursuit to continue to dominate all sectors of the beer market, Anheuser-Busch has tapped into the microbrewing trend. They have recently bought a stake in the Seattle based Red Hook Ale micro-brewery. The new products introduced into the regional and mainstream specialty beer segment include Red Wolf, Elk Mountain Red, Elk Mountain Amber Ale, and Elephant Red.

Since microbrews are typically produced regionally, Anheuser-Busch is developing regional manufacturers and distributors. As such, they must decide on the best way to handle their short-term cash needs for purchasing inventory in these small plants. Anheuser-Busch has decided to use the Baumol model to determine the level of cash to keep on hand versus the amount to keep in marketable securities.

Anheuser-Busch can earn 7% if they keep their funds in marketable securities. Every time they convert their marketable securities to cash, it costs them $25. Finally, they anticipate their total cash outlays over the next year to be $2,000,000.

1. Using the Baumol Model, what is the economic conversion quantity (ECQ) that will maximize the firm's value given their short-term cash needs? Why is it important for a business to correctly determine their ECQ?

2. Based on your answer from question 1, how many times will Anheuser-Busch convert marketable securities into cash per year?

3. What is the average cash balance the firm will hold throughout the year, assuming the cash outflows will occur on a consistent or smooth basis?

4. What is the total cost associated with managing these short-term funds? How can you be sure this is the optimal ECQ?

5. In the above analysis, we have not considered a level of safety stock. Why is safety stock so important? What primary factor will determine the amount of safety stock for each specific firm?

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