International Journal of Mathematics and

Computer Applications Research (IJMCAR)

ISSN(P 2249-6955; ISSN(E): 2249-8060
Vol. 6, Issue 2, Apr 2016, 43-56
TJPRC Pvt. Ltd.

INVENTORY MODEL WITH STOCK DEPENDENT DEMAND

RATE USING DISCOUNTED CASH FLOW APPROACH WITH
TRADE CREDIT PERIOD AND INFLATION
R. BABU KRISHNARAJ
Associate Professor, Department of Mathematics Hindusthan College of Arts & Science, Coimbatore, Tamil Nadu, India
ABSTRACT
In this paper, we are using an Inventory model for deteriorating of items using discounted cash flow approach
of credit period. Here the demand rate is considered as a stock dependent. Mathematical models are derived for three
different cases and a numerical example, sensitivity analysis are considered.
KEYWORDS: Credit System, Inventory, Weibull Distribution AMS Classification :90B05

Received: Feb 24, 2016; Accepted: Mar 08, 2016; Published: Mar 22, 2016; Paper Id.: IJMCARAPR201605

Several authors have studied inventory models of deteriorating items with constant market demand, time
dependent demand rate, and power demand rate using deterministic and probabilistic cases with or without
shortages. The items that can deteriorate or lose values under normal conditions such as meat, fish, sea food,
poultry, diary products, fruits and vegetables, some special type of medicines, radioactive substances etc., often

Original Article

1. INTRODUCTION

transportation of which also needs special care. In most of the cases, these items should be used within a short
period of time after delivery, as it may not be possible to preserve them in the same manner after delivery. It
reduces the cost of holding stock in advance. This approach is named as a discounted cash flow approach. Jaggi
and Aggarwal [14] have studied about the credit financing in economic ordering policies of deteriorating items.
Further it has been extended to a study of optimal retailers policies in the EOQ model under trade credit financing
by Huang [10].
In all these works they have followed the discounted cash flow approach. The DCF models are the one
that a form of financial processing models that have been used for investment returns and also in corporate risk
considerations in the target return on capital figure. Alternate to this approach is capital asset pricing and the
option pricing model. Further Aggarwal et. al., [1], studied an Inventory system with the effect of inflation and
credit period. Because, inflation plays an important role in the inventory nowadays. Inflation says that money is
the asset which is utilized by people to purchase goods and services on a regular basis. Inflation occurs in an
economy when the overall prices level increases and the demand of goods and services increases. Inflation is a
phenomenon which takes the whole economy into its grasp. It spreads across the whole of the economy with the
rise in the supply of money the price rate rises and the value of money falls that is devaluation of money takes
place.

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44

R. Babu Krishnaraj

Hence, in the recent study, Neetu et. al., [24] have studied the probabilistic inventory model for deteriorating
items in the presence of trade credit period using discounted cash flow approach and the authors gave more importance to
the inflation and time value of money. So, in this work, we are using an Inventory model for deteriorating of items using
discounted cash flow approach of credit period with stock dependent demand rate considering money value and inflation.

2. ASSUMPTIONS

Deterioration follows two parameter Weibull distribution.

Replenishment is instantaneous.

No Shortages.

There is no replacement of items during the period.

Inflation and time value of money is considered.

The demand rate is stock-dependent, D(t) = a+bI(t),

3. NOTATIONS

C is unit cost of the item.

I is the order quantity

D(t) is the demand rate at time t.

i is inventory holding cost fraction.

iC is the out-of pocket inventory carrying cost per unit time.

R is constant representing the difference between the discount rate and inflation rate.

H is the ordering cost per unit.

I(t) is the inventory level at time t.

T1 is the optimal cycle time for case I.

T2 is the optimal cycle time for case II.

T3 is the optimal cycle time for case III.

Z1 (T) is the present value of all future cash-flows for case I.

Z 2 (T) is the present value of all future cash-flows for case II.

Z 3 (T) is the present value of all future cash-flows for case III.

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Inventory Model with Stock Dependent Demand Rate using Discounted

Cash Flow Approach with Trade Credit Period and Inflation

Z1 (T1 )

Z 2 (T2 ) is the present value of all future cash-flows for case II.

Z 3 (T3 )

45

is the present value of all future cash-flows for case I.

is the present value of all future cash-flows for case III.

4. MATHEMATICAL FORMULATION
The level of inventory at time t is depends due to market demand and deterioration. The differential equation
describing the inventory system over (0,T) is given by,

dI (t )
+ t 1 I (t ) = (a + bI (t )),
0t T
dt

(4.1)

With the boundary condition, I(T)=0

The solution of equation (4.1) is,

a (T t ) +
(T +1 t +1 ) + (T 2 t 2 ) (1 t bt )
+1
2

I(t) =
Assuming

(4.2)

(0 1) , the solution is obtained by neglecting the second and higher order terms of .

b
a T +
T +1 + T 2
+1
2
Order quantity, Q = I(0) =

(4.3)

The number of deteriorating units during one cycle,

T

D(t )dt

D(T) = Q -

(a + bt )dt

=Q-

b
b
a T +
T +1 + T 2 aT + T 2
+1
2
2
=

T +1
+1

(4.4)

Using DCF approach,

Case I: Instantaneous cash-flows:
At the beginning of each cycle, there will be cash out flows of ordering cost and purchasing cost. Since, the
inventory carrying cost is proportional to the value of the inventory. The present value of cash flow for the first order cycle
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46

Z1 (T)

R. Babu Krishnaraj

is
T

Z1 (T)

I (t )e

= H + CQ + iC

Rt

dt

b
a T +
T +1 + T 2
2 +
+1
=H+C

a (T t ) + + 1 (T

+1

iC 0

b
t +1 ) + (T 2 t 2 ) (1 t bt )e Rt dt
2

b
a T +
T +1 + T 2
2 +
+1
=H+C

Rt

b 2 2
+1
+1

a
(
T

t
)
+
(
T

t
)
+
(
T

t
)

(
T

t
)
t

b
(
T

t
)
t

e dt
0
2
+1

iC
T

b
a T +
T +1 + T 2
2 +
+1
=H+C
T

iCa

(T t ) + + 1 (T
0

+1

b
t +1 ) + (T 2 t 2 )
2

(T t )t b(T t )t (1 Rt )dt

a T +
T +1 + T 2
2 +
+1
=H+C

t2

t +2
b
+1
Tt

+
T
t

+ T 2t

2 +1
( + 1)( + 2) 2
iCa
T

2
bt Tt +1 t + 2 bTt
bt 3
Rt 3

RT t 2 +
+1 + 2 2
6
3
2 0
-

b
a T +
T +1 + T 2
+1
2 +
=H+C

iCa

T 2 T +2
T +2
RT 3 bT 3

2
2
+ 1 ( + 1)( + 2)
2

Impact Factor (JCC): 4.6257

(4.5)
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Inventory Model with Stock Dependent Demand Rate using Discounted

Cash Flow Approach with Trade Credit Period and Inflation

47

b
a T +
T +1 + T 2

Z (T) = RT H + C
2 +
+1
ie., 1

T 2 T +2
T +2
RT 3 bT 3

2
2
2
+ 1 ( + 1)( + 2)

iCa

b
a 1 +
T + T1

R H + C +1
2 +
=

T T +1
T +1
RT 1 bT 2

2
+
2
(
+
1)(
+
2)
2
2

iCa
T bT
T T +1
1 H
T +1
bT 2 RT 2
Ca
1
iCa
+
+
+
+

R T
2
2
+1 2
2 + 2 ( + 1)( + 2)
=

The optimal value of T can be found by solving,

(4.6)

Z1 (T )
T =0,

Differentiating equation (4.6) partially w.r.t. T and equating to zero, we get,

1

Z1 (T ) 1 H + Ca T + b + iCa 1 ( + 1) T

2
2
2
( + 2)
+1
T = R T

bT RT
( + 2)

=0

(4.7)

2
1
2 Z1 (T ) 1 H + Ca ( 1)T iCa ( + 1)T

2
R T 3
+1
+2

and T
=

T 1
+b+ R
+2

Thus optimum value of T can be found from equation (4.7). Let it be

T1

. Then, the optimum value of order

b
a T1 +
T1 +1 + T12
I (t )
2 and minimum cost Z1 (T1 ) can be found from equation (4.6).
+1
quantity 1
=
Case II:
In this case, payment is connected to the subsequent use of items. Here, the credit period is M. During this period,
the customers make payment to the supplier immediately after the use of the items and the remaining balance is paid by the
customer on the last day of the credit period.

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48

R. Babu Krishnaraj

If T

M, then the present value of cash flows for the first cycle is,

Z 2 (T)

H + C (a + bt ) e Rt dt + CD(T )e RM + iC I (t )e Rt dt
=
T

H + C (a + bt )(1 Rt )dt + CD(T)(1 RM)

0

b
a (T t ) +
(T +1 t +1 ) + (T 2 t 2 ) (1 t bt )
+1
2

e Rt dt

+iC 0

H + C (a aRt + bt Rbt 2 )dt + C

0

a (T t ) + + 1 (T

+1

+ iC 0

T +1
(1 RM )
+1

b
t +1 ) + (T 2 t 2 ) (T t )t b(T t )t e Rt dt
2

aRt 2
Rbt 3 C T +1
+ bt
H + C at
(1 RM )
+
+1
2
3 0

T 2 T +2
T +2
RT 3 bT 3

2
2
2
+ 1 ( + 1)( + 2)

+ iCa

aRT 2
RbT 3 C T +1
H + C aT
+ bT
(1 RM )
+
+1
2
3

+ iCa

T 2 T +2
T +2
RT 3 bT 3

2
2
+ 1 ( + 1)( + 2)
2

(4.8)

b)
If T

M, then the present value of cash flows for the first cycle is,
M

Z 2 (T)

H + C (a + bt )e
=

Rt

M
T

RM
dt + C Q (a + bt ) dt e
+ iC I (t )e Rt dt
0
0

aRt 2
Rbt 3
H + C at
+ bt

2
3 0

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Inventory Model with Stock Dependent Demand Rate using Discounted

Cash Flow Approach with Trade Credit Period and Inflation

49

b 2
+1
T + T (a + bt )dt e RM
a T +
+1
2 0

+C

T 2 T +2
T +2
RT 3 bT 3

2
2
2
+ 1 ( + 1)( + 2)

+ iCa

aRM 2
RbM 3
H + C aM
+ bM

2
3

b 2
bM 2
+1
a T + + 1 T + 2 T aM + 2 (1 RM )

+C

T 2 T +2
T +2
RT 3 bT 3

2
2
2
+ 1 ( + 1)( + 2)

+ iCa

(4.9)

The present value of all future cash flows is,

aRT 2
RbT 3 C T +1
1
H + C aT
+ bT
(1 RM )
+
RT
2
3
+
1

Z 2 (T)

=
T 2 T +2
T +2
RT 3 bT 3

2
2
2
+ 1 ( + 1)( + 2)

+ iCa

aRT
RbT 2 C T
1 H
+ C a
+b
(1 RM )
+
RT
2
3
+1

=
T 1 T +1
T +1
RT 2 bT 2

2
2
2
+ 1 ( + 1)( + 2)

+ iCa
for T M

(4.10)

1
aRM 2
RbM 3
H
+
C
aM

+
bM

2
3
Z (T) = RT

and 2

b 2
bM 2
+1
a
T
+
T
+
T

aM
+
(1 RM )

+
1
2
2

+C

T 2 T +2
T +2
RT 3 bT 3

2
2
2
+ 1 ( + 1)( + 2)

+ iCa

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50

R. Babu Krishnaraj

aRM 2
RbM 3
1 H C
+
aM

+
bM

2
3
R T T
=

b 1
T + T
a 1 +
2 T
+1
+C

bM 2
aM
+

(1 RM )
2

T T +1
T +1
RT 2 bT 2

2 + 1 ( + 1)( + 2)
2
2

+ iCa
for T M

The necessary condition for

Z 2 (T)

(4.11)

Z 2 (T )
T = 0,
to be minimum is

aR Rb2T C T 1
1 H
Z 2 (T )
2 + C
(1 RM )

+
R T
2
3
+
1

T =
1 T
T
RT
bT

2
1
( + 2)
1
1
+ iCa

(4.12)

and
2
3
Z 2 (T ) 1 H C aM aRM + bM RbM

2

T2
2
3
T = R T

1 b 1
bM 2
T + + 2 aM +
a
(1 RM )
+
1
2
T
2

+C

1 T
T
RT
bT

2
1
( + 2)
1
1
+ iCa

(4.13)

2 Z 2 (T ) 1 H3 + C Rb 2 + C ( 1)T
(1 RM )
3
R T
+
1

T
=

T 1 T 1

R b

1
( + 2)
0 for T M
+ iCa
2
3
2 Z 2 (T ) 1 H + C aM aRM + bM RbM

3 T3
2
3

T 2 = R T
and

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Inventory Model with Stock Dependent Demand Rate using Discounted

Cash Flow Approach with Trade Credit Period and Inflation

51

( 1) 2 1
bM 2
T

aM
+
a
(1 RM )
T3
+1
2

+C

T 1 T 1

1
( + 2)

+ iCa
0 for T M
and the optimum value of T =

T2

can be found from equation (4.12) and (4.13).

Case III: Fixed Credit Period:

In this case credit period is fixed
The present value of cash-flows for one cycle,

Z 3 (T)

H + CQe

RM

Z 3 (T) is

+ iC I (t )e Rt dt
0

b 2 RM
+1
H + Ca T +
T + T e
+ iC I (t )e Rt dt
2
+1

0
=

b
H + Ca T +
T +1 + T 2 (1 RM )
2
+1

T T +1
T +1
RT 3 bT 3

2 + 1 ( + 1)( + 2)
2
2

+ iCa

(4.14)

The present value of all future cash-flows is,

b
H + Ca T +
T +1 + T 2 (1 RM )

Z 3 (T) = RT
2
+1

T T +1
T +1
RT 3 bT 3

2 + 1 ( + 1)( + 2)
2
2

+ iCa

1 H

b
+ Ca 1 +
T + T (1 RM )

R T
2
+1
=

1 T
T
RT 2 bT 2

2 + 1 ( + 1)( + 2)
2
2

+ iCa

(4.15)

For optimum value of T,

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52

R. Babu Krishnaraj

Z 3 (T ) 1 H + Ca T 1 + b (1 RM )

+1
2
2

T = R T

T 1
T 1
RT
bT

1
1
+ 1 ( + 1)( + 2)
+ iCa

(4.16)

2 Z 3 (T ) 1 H + Ca ( 1) T 2 (1 RM )
+1

2
R T 3

and T
=

( 1)T 2 ( 1)T 2

R b

( + 1)( + 2)
+1

+ iCa
Hence, the optimum value of T =

(4.17)

T3 can be obtained from equation (4.16) and the corresponding optimal order

b
I 3 = a T3 +
T3 +1 + T32
2
+1

quantity is I =
The corresponding optimal present value of all future cash-flows

Z 3 (T) = Z 3 (T3 ) is obtained from equation

(4.15), equation (4.16) contains trade credit.

Numerical Example
Case I
Let

= 0.001,

= 1, i = 0.20, C = 20, H = 250, a = 1.1 b =0.5

T = 50days = 0.1369 year, M =100 days = 0.27399 years,

Sensitivity analysis on R
Table 1
R

Z1 (T)

0.15
0.18
0.21
0.24
0.27
0.3

12327.86
10273.21
8805.6
7704.9
6848.79
6163.91

ie., the decrease in present value of cash-flows with increase in R

Sensitivity analysis on C
Parameters are same.

Impact Factor (JCC): 4.6257

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Inventory Model with Stock Dependent Demand Rate using Discounted

Cash Flow Approach with Trade Credit Period and Inflation

53

Table 2
C

Z1 (T)

15
20
25
30
35
40

12289.48
12327.86
12366.24
12404.62
12443.01
12481.39

ie., with increase in C, Z 1 (T) increases.

Case II
Example 2
Let

= 0.001,

= 1, i = 0.20, C = 20, H = 250, a = 1.1, b =0.5

T = 50days = 0.1369 year, M =100 days = 0.27399 years,

Since T

M, this is sub case I.

Sensitivity analysis on R
Sub case I
Table 3
R

Z 2 (T)

0.15
0.18
0.21
0.24
0.27
0.3

254.39
254.38
254.37
254.3665
254.3599
254.3533

ie., the increase in R, present value of future cash-flows decreases

Sensitivity analysis on C
Sub Case II
Table 4
C

Z 2 (T)

15
20
25
30
35
40

253.2897
254.3863
255.4829
256.5795
257.6761
258.7727

With increase in C, the present value of future cash-flows increases.

If all the parameters are same as example 2, let T = 50 daysm M = 30 days,

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54

R. Babu Krishnaraj

that is, T

M, then this is the sub case II.

Sensitivity analysis on R
Sub case II
Table 5
R

Z 2 (T)

0.15
0.18
0.21
0.24
0.27
0.3

12364.92
10303.87
8831.7
7727.57
6868.8
6181.78

With increase in R, present value of future cash-flows decreases.

Sensitivity analysis on C
Sub case II.
All the parameters are same.
Table 6
C

Z 2 (T)

15
20
25
30
35
40

12317.28
12364.92
12412.57
12460.21
12507.86
12555.51

With increase in C, the present value of future cash-flows increases.

Case III
Example 3
Let

= 0.001,

= 1, i = 0.20, C = 20, H = 250, a = 1.1, b = 0.5

T = 50days = 0.1369 year, M =75 days,

Sensitivity analysis on R
Table 7

Impact Factor (JCC): 4.6257

Z 3 (T)

0.15
0.18
0.21
0.24
0.27
0.3

12335.84
10279.08
8809.97
7708.13
6851.15
6165.56

NAAS Rating: 3.80

Inventory Model with Stock Dependent Demand Rate using Discounted

Cash Flow Approach with Trade Credit Period and Inflation

55

With increase in R, the present value of cash-flow decreases.

Sensitivity analysis on C
All the parameters are same, R = 0.15
Table 8
C

Z 3 (T)

15
20
25
30
35
40

12295.47
12335.84
12376.22
12416.6
12456.97
12497.35

With increase in C, the present value of future cash-flow increases.

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