Inventory and financing decisions in a firm

The capital market has for a long time been supposed to be perfect in inventory models. Recently, certain authors have focused on the influence of the capital market imperfections on inventory decisions. In order to explain these imperfections, Guariglia (2000) combines the agency cost theory with the following assumption: inventories can be reasonably readily converted into cash, so that they can be seen as collateral for short-term borrowing and a signal for creditors to the firm's financial solidity. In this paper, we criticize the assumption of Guariglia, and propose another way of explaining the imperfections in question: if the firm meets difficulties in repaying its debts, its unpaid creditors consent to a new term of payment, but the firm must then bear penalty charges depending on the size of its difficulties. From this assumption, we build a model aiming to explain simultaneously the inventory, cash and financing decisions of a short-term reasoning firm. It is a two period model with uncertainty. The firm aims to maximise its assets value at the end of the plan. It can raise two sorts of borrowings to finance its decisions, of different durations and interest rates. The last assumption allows a study of unusual questions in inventory theory, such as the separation (or not) of the inventory and the financing decisions, and optimal financing. We don't a priori postulate the nature of the capital market, which may be perfect or imperfect according to the data facing the firm. We compare the features Of the inventory and financing decisions in these two cases.