Average Costs Versus Net Present Value
24 Pages Posted: 26 Aug 2006
Date Written: June 2000, 11
While the net present value (NPV) approach is widely accepted as the right framework for studying production and inventory control systems, average cost (AC) models are more widely used. For the well known EOQ model it can be verified that (under certain conditions) the AC approach gives near optimal results, but does this also hold for more complex systems? In this paper it is argued that for more complex systems, like multi-source systems, one has to be extremely careful in applying the AC approach on intuition alone, even when these systems are deterministic. Special attention is given to a two-source inventory system with manufacturing, remanufacturing, and disposal, and it is shown that for this type of models there is a considerable gap between the AC approach and the NPV approach.
Keywords: net present value, average costs, inventory control, holding costs, remanufacturing
JEL Classification: M, M11, R4
Suggested Citation: Suggested Citation