Optimal Ordering Policies Under Conditions of Extended Payment Privileges

This paper develops optimal order quantities for firms that are offered a one-time opportunity to delay payment for an order of a commodity. Such delayed payments result in a reduction of the effective purchase cost, which is a function of the return available on alternative investments, the number of units of the commodity ordered, and the length of the extended period. Optimal order quantities are developed for extended payment privileges that occur at a reorder point of between reorder points. Six suppliers' extended payment scenarios are evaluated. A simulation analysis is conducted to determine the sensitivity of derived models to changes in the various input parameters. The simulation with realistic parameter values reveals that the additional discounted order quantity is insensitive to large changes in the ordering cost and unit price; sensitive to changes in the carrying cost and return rate of funds, but without significantly affecting the total cost; and extremely sensitive to the annual demand. Simple analytic decision rules are provided to guide firms that are offered such extended payment privileges.