Financial risk, inventory decision and process improvement for a firm with random capacity

Companies strive to maximize their value on the financial market and tailor their inventory decisions to achieve this goal. In this paper, we consider a company aiming to maximize its firm value in a newsvendor setting with a randomly capacitated supplier and a stochastic demand correlated with the market return. We employ the Capital Asset Pricing Model to evaluate firm value. We demonstrate that while the optimal order quantity is independent of the supplier’s random capacity, firm value is not. Building on this firm-value/random-capacity dependence, we next explore the impact of capacity process improvements on firm value and establish when and how such improvements will contribute to firm value the most. We also identify several factors that moderate the impact of capacity process improvements on firm value. Our research results should help managers to select suppliers who would contribute to firm value maximization.