On the Cost of Capital in Inventory Models: The Case of Deterministic Demand

Alejandro Serrano

Foundations and Trends(R) in Technology, Information and Operations Management, 2017, vol. 10, issue 3-4, 338-357

Abstract: In the operations management literature, the financial risk in an inventory model is usually assumed to be captured by the (constant) weighted average cost of capital (WACC) of the firm. This assumption is, at best, an approximation, since this cost depends on the risk of the cash flows, which, in turn, depends on the inventory policy. This paper explores what the right cost of capital should be in an inventory model with deterministic demand. We find that, in contrast to other existing models, risk is not in general a monotone function of inventory. Also, a rate close to the risk-free rate, which typically deviates significantly from the WACC, should be used to value inventory-related investments when the inventory cost function is dominated by holding cost for large order quantities, even if investments are subject to other sources of financial variability.

Keywords: Supplier financing; Supply chain finance; Cost of capital (search for similar items in EconPapers)
JEL-codes: G20 G32 M11 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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