Capital Structure and Inventory Management

Abstract

We examine the impact of a firm’s capital structure on its short-term decisions concerning inventories, dividends, and liquidity. The model is a single-stage inventory system with the criterion of maximizing the value of the firm, namely the expected present value of dividends. In a linear-cost case, the model is a dynamic newsvendor, and there is an optimal base-stock inventory policy which does not depend on the firm’s capital structure. However, the optimal dividend and liquidity policy depends on the inventory decisions. Without making linearity assumptions, the optimal capital structure depends on all parameters. However, sucient conditions for the optimum to be all-debt or all-equity depend only on financial parameters. We also show that a base-stock policy, optimal or not, has the “smoothing eect” that the

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