Financial Cost Inclusive Reformulations of Inventory Lot Size Models

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Inventory systems for deterministic demand have been extensively discussed in the literature. Generally, lot size models have been developed to minimize per-period total inventory costs. Financial management theory, however, strongly suggests that the fundamental objective of management is to maximize shareholder wealth. Thus, in theory, inventory policy decisions should be made within a net present value, wealth maximization context. This paper reformulates the uniform replenishing rate inventory model in a present value framework under two cash-flow scenarios. In the first scenario, which is shown to be equivalent to the classical EOQ model, it is demonstrated that the classical EOQ methodology is consistent with the present value reformulation. In the second scenario, which is consistent with the classical uniform replenishing rate model, the present value reformulation recommends substantially higher optimal order quantities than the classical model and provides insight about both the traditional methodology and future uses of the present value methodology.