Foundations and Trends® in Technology, Information and Operations Management > Vol 10 > Issue 3-4

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

Alejandro Serrano, IESE Business School and Zaragoza Logistics Center, Spain, aserrano@iese.edu
 
Suggested Citation
Alejandro Serrano (2017), "On the Cost of Capital in Inventory Models: The Case of Deterministic Demand", Foundations and Trends® in Technology, Information and Operations Management: Vol. 10: No. 3-4, pp 338-357. http://dx.doi.org/10.1561/0200000060

Published: 21 Dec 2017
© 2017 A. Serrano
 
Subjects
 
Keywords
G20 Financial ServicesG32 Financial Risk and Risk ManagementM11 Production management
Supplier financingSupply chain financeCost of capital
 

Free Preview:

Article Help

Share

Login to download a free copy

Free until: 21 January 2018

In this article:
1. Motivation and Description of the Problem
2. Modeling Approach and Methodology
3. Results and Insights
4. Conclusions and Further Research
References

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.

DOI:10.1561/0200000060
ISBN: 978-1-68083-376-8
272 pp. $99.00
Buy book
 
ISBN: 978-1-68083-377-5
272 pp. $260.00
Buy E-book
Table of contents:
Supply Chain Finance: Overview and Future Directions
Part 1: Supplier Financing
Agency Cost of Debt: A Case for Supplier Financing
Trade credit as an option to acquire financing
Impact of Trade Credit Financing on Firm Performance in Supply Chains
Part 2: Buyer Financing
Reverse factoring: A theory on the value of payment terms extension
Improving Channel Efficiency through Financial Guarantees by Large Supply Chain Participants
Purchase Order Finance: A Conceptual Model with Economic Insights
Part 3: Inventory Models and Financing Considerations
Managing Inventory for a Multidivisional Firm with Cash Pooling
On the Cost of Capital in Inventory Models
Part 4: Operational Investments and Financing Issues
Debt Financing and Supply Chain Capacity Investment
Production, Capacity, and Liquidity of a Self-Financed Firm
Supply Chain Debt Financing in Competition
References
Crowdfunding via Revenue-Sharing Contracts

Supply Chain Finance

Supply Chain Finance focuses is on creating liquidity in the supply chain through various Buyer or Seller-led solutions with or without a facilitating technology. The role of supply chain finance (SCF) is to optimize both the availability and cost of capital within a given buyer-supplier supply chain. To add further value, information on the physical flow of goods can be monitored. The coupling of information enables lenders to mitigate financial risk within the supply chain. The mitigation of risk allows more capital to be raised, capital to be accessed sooner, or capital to be raised at lower rates. Supply chain participants reside in diverse economic environments, are of different sizes, face a variety of uncertainties, have different bargaining powers over its trading partners, and have different accessibilities to capital markets. Many forms of financing arrangements between buyers and suppliers have emerged intending to overcome challenges in their specific economic and business environments.

Part 1 examines Supplier Financing. The three papers included in this section discuss supplier based financing issues including: motivation and rationale for supplier based financing, the optimal mix of bank financing and supplier financing, and empirical study of the impact of trade credit on firm performance. Part 2 focuses on Buyer Financing including three papers included that discuss buyer based financing issues in supply chains including the rationales of different types of buyer based financing arrangements and their impacts on supply chain performance. Part 3 reviews Inventory Models and Financing Consideration and the two papers in this part of the book explore how to coordinate the management of the cash flow and inventory flow within an organization and the relationship between a firm’s inventory policy and its cost of capital. Part 4 examines Operational Investments and Financing Issues and includes four papers that address operational investments with explicit financing considerations.

 
TOM-060

Companion

Foundations and Trends® in Technology, Information and Operations Management, Volume 10, Issue 3-4 Special Issue: Supply Chain Finance
See the other articles that are also part of this special issue.