Inflation, taxes, and optimal inventory policies

Abstract

This study employs an alternative stochastic model which offers important advantages over those proposed by Cohen and Pekelman, and Biddle and Martin. Rather than optimizing with respect to a single order-up-to level determined at the start of each year, the model permits a second order at year-end. This achieves greater descriptive validity by allowing intrayear (as well as interyear) cost changes and additional purchases after demand has been assessed. More important, there is a greater sensitivity to the effects of tax incentives on year-end procurement decisions and a smaller likelihood of year-end stockouts (which unrealistically affect tax incentives by drastically altering inventory cost structures).

As a result, the model is uniquely suited for an examination of optimal choices among alternative inventory costing methods and the optimal ordering policies under each. In this study we extend the model to include not only LIFO and FIFO but also AC, a method not previously considered in order quantity models.