292 Int. J. Services Operations and Informatics, Vol. 6, No.

4, 2011

Credit financing for deteriorating imperfect-quality

items under inflationary conditions

Chandra K. Jaggi* and Aditi Khanna

Department of Operational Research,
Faculty of Mathematical Sciences,
New Academic Block,
University of Delhi,
Delhi 110007, India
Email: ckjaggi@or.du.ac.in
Email: ckjaggi@yahoo.com
Email: aditik06@rediffmail.com
*Corresponding author

Mandeep Mittal
Amity School of Engineering & Technology,
580 Delhi Palam Vihar Road,
Bijwasan, New Delhi 110061, India
Email: mittal_mandeep@yahoo.com

Abstract: In today’s technology-driven world, despite of efficient planning

of manufacturing system and emergence of sophisticated production methods
and control systems; the items produced have some fraction of defectives.
However, these defective items can be removed from the lot through a
screening process. Thus, the inspection of lot becomes essential, especially
when items are deteriorating in nature. Further, in today’s uncertain global
economy, due to rising inflation there is a consequent decline in the real value
of money, which eventually forces the supplier to provide an attractive trade-
credit policy to the retailer. Keeping this scenario in mind, an attempt has been
made to formulate an inventory policy for a retailer dealing with imperfect
quality items of deteriorating nature under inflation and permissible delay
in payments. Results have been demonstrated with the help of a numerical
example and sensitivity analysis is also presented to provide managerial
insights into practice.

Keywords: inventory; imperfect items; deterioration; inflation; trade credit.

Reference to this paper should be made as follows: Jaggi, C.K., Khanna, A.

and Mittal, M. (2011) ‘Credit financing for deteriorating imperfect-quality
items under inflationary conditions’, Int. J. Services Operations and Informatics,
Vol. 6, No. 4, pp.292–309.

Biographical notes: Chandra K. Jaggi is Associate Professor in the

Department of Operational Research, University of Delhi, India. His research
interest lies in the field of analysis of inventory management. He has published
more than 65 papers in various international/national journals. He has guided
six PhD and 13 MPhil students in Inventory Management. He is Editor-in-
Chief of IJICM. He is Associate Editor of IJSAEM, Springer, and on the
Editorial Board of the IJSOI. He was awarded Shiksha Rattan Puraskar

Copyright © 2011 Inderscience Enterprises Ltd.

 Credit financing for deteriorating imperfect-quality items 293

(for Meritorious Services, Outstanding Performance and Remarkable Role) in

2007 He has travelled extensively in India and abroad and delivered invited
talks.

Aditi Khanna is a Research Scholar in the Department of Operational

Research, Faculty of Mathematical Sciences, University of Delhi, India. She is
also working as an Assistant Professor in the Department of Mathematics,
Keshav Mahavidayalya, University of Delhi, India. She completed her PhD
(Inventory Management) in 2010, MPhil (Inventory Management) in 2004, and
MSc (Operational Research) in 2002 from the University of Delhi. She has
eight research papers published in Canadian Journal of Pure & Applied
Sciences, International Journal of Applied Decision Sciences, International
Journal of Procurement Management, International Journal of Operational
Research, International Journal of Mathematics in Operational Research,
OPSEARCH, Mathematics Today and International Journal of System
Sciences, respectively.

Mandeep Mittal is a Research Scholar in the Department of Operational

Research, Faculty of Mathematical Sciences, University of Delhi, India.
He is also working as an Assistant Professor in the Department of Computer
Science and Dean (Student’s Activities) at Amity School of Engineering &
Technology, New Delhi, India. He has completed his MSc (Applied
Mathematics) in 2000 from IIT Roorkee. He has four research papers published
in International Journal of Industrial Engineering Computations, International
Journal of Strategic Decision Sciences, Revista Invetigacion Operacional and
Indian Journal of Mathematics and Mathematical Sciences and one research
paper is to appear in International Journal of Applied Industrial Engineering.

1 Introduction

Generally, every manufacturing system wants to produce 100% good quality products.
However, in reality certain fraction of products may be of imperfect quality due to labour
problem or machine breakdown, etc. The defective items are picked up during the
screening process and are withdrawn from the stock at the end of the screening process.
The retailer incurs additional cost due to rejection of these defective items. Thus,
inspection of lot becomes essential in most of the organisations. By considering this very
fact, researchers developed various economic production quantity (EPQ)/economic order
quantity (EOQ) models with defective items. Porteus (1986) incorporated the effect of
defective items into the basic EOQ model. He assumed that there is some probability that
the process would go out of control while producing one unit of the product. Rosenblatt
and Lee (1986) assumed that the time from the beginning of the production run, i.e., the
in-control state, until the process goes out of control is exponential, and the defective
items can be reworked instantaneously at a cost and concluded that the presence of
defective products motivates smaller lot sizes. Later, Lee and Rosenblatt (1987)
considered using process inspection during the production run so that the shift to out-of-
control state can be detected and restoration made earlier. Salameh and Jaber (2000)
extended the work done on imperfect-quality items under random yield and developed
economic order quantity which contradicts the findings of Rosenblatt and Lee (1986) that
the economic lot size tends to decrease as average percentage of imperfect-quality items
increases. Cárdenas-Barrón (2000) corrected EOQ formula obtained by Salameh and
294 C.K. Jaggi, A. Khanna and M. Mittal

Jaber (2000) by inserting a constant parameter which was missing in Salameh and Jaber’s
(2000) model formulation. Further, Goyal and Cárdenas-Barrón (2002) presented a
simple approach for determining economic order quantity for imperfect items and
compared the results based on the simple approach with optimal method suggested by
Salameh and Jaber (2000) for determining the lot size and showed that almost optimal
results are obtained using simple approach. Papachristos and Konstantaras (2006)
examined the Salameh and Jaber (2000) paper closely and rectified the proposed
conditions to ensure that shortages will not occur. Maddah and Jaber (2008) corrected
Salameh and Jaber’s (2000) work related to the method of evaluating the expected profit
per unit time. They applied renewal-reward theorem (Ross, 1996) to obtain the exact
expression for the expected profit per unit time.
Further, when the items are deteriorating in nature, role of inspection becomes
more prominent. In fact, in all the aforementioned papers, authors have not considered
deterioration factor in their modelling, whereas deterioration is a well-established fact in
literature, due to which utility of an item does not remain same over the period of time.
Ghare and Schrader (1963) were first to present an EOQ model for exponentially
decaying inventory. Thereafter, several interesting papers for controlling the deteriorating
items have appeared in different journals which have been summarised by Raafat
et al. (1991).
Moreover, in today’s unstable global economy there is constant decline in the
real value of money, because the general level of prices of goods and services is rising
(i.e., inflation). In the past several years many countries have suffered from large-scale
inflation and sharp decline in the purchasing power of money. Besides this, inflation
also influences demand of certain products: as inflation rate increases the value of
money goes down which erodes the future worth of savings and forces one for more
current spending. This expenditure may be on clothes, accessories, peripherals or daily
household items. As a result, while determining the optimal inventory policy, the effect
of inflation should not be ignored. Many authors have developed different inventory
models under inflationary conditions with different assumptions. The fundamental result
in the development of the EOQ model with inflation is that of Buzacott (1975) who
discussed the EOQ model with inflation subject to different types of pricing policies.
In the same year Misra (1975) also developed an EOQ model incorporating inflationary
effects. Several other interesting and relevant papers in this direction are Datta and Pal
(1991), Sarker and Pan (1994), Hariga (1995) and Hariga and Ben-Daya (1996).
Furthermore, in order to sustain in this sliding growth, rising inflation and volatile
markets, the supplier offers a credit policy to the retailer in which the retailer does not
have to pay the supplier immediately after receiving the goods, but instead can defer the
payment until the end of the allowed period. The trade credit policy being offered by the
supplier serves as an added advantage to the retailer. The supplier allows a certain fixed
period to the retailer to settle the payment account. During this period, no interest is
charged by the supplier, but beyond this period interest is charged under certain terms
and conditions agreed upon since inventories are usually financed through debt or equity.
In case of debt financing, it is often a short-term financing. Thus, interest paid here is
nothing but the cost of capital or opportunity cost. Also, short-term loans can be thought
of as having been taken from the supplier on the expiry of the credit period. However,
before the account has to be settled, the customer can sell the goods and continues to
accumulate revenue and earn interest. Interest earned can be thought of as a return on
investment since the money generated through revenue can be ploughed back into the
business. Therefore, it makes economic sense for the customer to delay the settlement of
 Credit financing for deteriorating imperfect-quality items 295

the replenishment account up to the last day of the credit period allowed by the supplier.
Kingsman (1983) explored the effects of payment rules on ordering and stocking in
purchasing. Goyal (1985) and Davis and Gaither (1985) developed economic order
quantity under conditions of permissible delay in payments. Mandal and Phaujdar (1989)
studied the buyer’s interest earned in the credit term. Aggarwal and Jaggi (1995)
extended Goyal’s (1985) model for deteriorating items by considering the point that if the
credit period is less than the cycle length, the customer continues to accumulate revenue
and earn interest on it for the rest of the period in the cycle, from the stock remaining
beyond the credit period. Since then, many research papers have appeared in different
journals, which have been summarised by Soni et al. (2010). However, Chung and Huang
(2006) presented an EOQ model with imperfect quality under permissible delay in
payments.
Further incorporating the effects of inflation, time value of money, deterioration, and
permissible delay in payment on inventory models, various research papers have been
published in the last decade, viz. Liao et al. (2000), Chang (2004), Manna and Chaudhri
(2005) and Jaggi and Khanna (2010).
However, none of the above-surveyed articles considered the effects of inspection on
deteriorating items with imperfect quality with permissible delay in payments under
inflationary conditions. In this paper, the common unrealistic assumption that all units
produced/purchased are of good quality has been relaxed, as each lot of the products
delivered may contain some defective items, due to certain unavoidable technical
reasons. Thus, inspection of lot becomes essential in every organisation, where the
screening rate is assumed to be more than the demand rate, in order to meet the demand
parallel to the screening process, out of the items which are of perfect quality. Moreover
the model has been developed incorporating two interesting phenomena, viz. inflation
and deterioration, in the presence of trade credit. Owing to their very nature, one
phenomenon pushes the cycle length and at the same time the other pulls the cycle
length. Moreover, credit policy being offered by the supplier provides an added
advantage to the retailer for deciding the optimal ordering policy. The proposed model
can be very helpful for the management of all retail establishments in developing
countries, for deciding their optimal inventory policy. A comprehensive sensitivity
analysis has also been performed to study the effects of deterioration, inflation, expected
number of imperfect-quality items and permissible delay in payments.

2 Assumptions and notation

The following assumptions are used in developing the model:

1 The demand rate is known, constant and continuous.
2 Shortages are not allowed.
3 The lead time is negligible.
4 The replenishment is instantaneous.
5 The screening and demand proceeds simultaneously, but the screening rate is
greater than demand rate.
6 The defective items are independent of deterioration.
7 The defective items exist in lot size.
296 C.K. Jaggi, A. Khanna and M. Mittal

8 The defective percentage has a uniform distribution.

9 Supplier offers a fixed credit period to the retailer to settle the accounts.
10 A Discounted Cash Flow (DCF) approach is used to consider the various
costs at various times.
The following notation is also used:
Q Order quantity per order
A Ordering cost per order
D Demand rate (units per unit time)
h Holding cost per unit per unit time
c Purchasing cost per unit per unit time
p Selling price per unit
ps Salvage value per defective unit, ps < c

β Screening cost per unit

r Discount rate, representing the time value of money
i Inflation rate
R r-i, representing the net discount rate of inflation is constant
M Permissible delay in settling the accounts
T Inventory cycle length
Ie Interest earned per unit per unit time
Ip Interest paid per unit per unit time, Ip≥ Ie
t1 Screening time
α Percentage of defective items in Q
f(α) Probability density function of α
b
E(α) Expected value of α, which is equal to α f (α ) dα ,
∫ a
0 < a < b <1

I1 (t ) Inventory level during time interval 0 ≤ t ≤ t1

I 2 (t ) Inventory level during time interval t1 ≤ t ≤ T

I eff (t1 ) Effective inventory level at time t1 excluding the defective items

π 1T (T ) Total profit for case 1, when M ≤ t1 ≤ T

π 2T (T ) Total profit for case 2, when t1 ≤ M ≤ T

π 3T (T ) Total profit for case 3, when t1 ≤ T ≤ M

 Credit financing for deteriorating imperfect-quality items 297

3 Mathematical model

In the present inventory system, Q items are procured at the beginning of the period. It is
assumed that each lot might have some defective items. Let α be the percent of defective
items with a known probability density function, f(α). Screening process is done for all
the received quantity at the rate of λ units per unit time which is greater than demand rate
(D) for the time period 0 to t1. During the screening process the demand occurs parallel to
the screening process and is fulfilled from the goods which are found to be of perfect
quality by the screening process. The defective items are sold immediately after the
screening process is over at time t1 as a single lot at a discounted price. After time t1 the
effective inventory level will be I eff (t1 ) . This inventory level gradually decreases mainly
due to demand and partially due to deterioration and reaches zero at time T. The
behaviour of the inventory level is depicted in Figure 1.

Figure 1 Inventory system with inspection for Case 1: M ≤ t1 ≤ T , Case 2: t1 ≤ M ≤ T and

Case 3: t1 ≤ T ≤ M

t1

Inventory
Level
αQ
Interest earned
Q

I(t1)

0 M M T M

Time

Let I(t) be the inventory level at any time t, 0 ≤ t ≤ T. The differential equations that
describe the instantaneous states of I(t) over the period (0, T) are given by:
dI1 (t )
+ θ I1 (t ) = − D , 0 ≤ t ≤ t1 (1)
dt
dI 2 (t )
+ θ I 2 (t ) = − D , t1 ≤ t ≤ T (2)
dt
The solution of the differential equation (1) along with the boundary condition, t = 0,
I1 (t ) = Q is:

D
I1 (t ) = Q e−θ t + ⎡e −θ t
−1⎤⎦ (3)
θ⎣
298 C.K. Jaggi, A. Khanna and M. Mittal

Inventory level at time t1, including the defective items is:

D
I1 (t1 ) = Q e−θ t1 + ⎡e −θ t1
−1⎤⎦ (4)
θ ⎣
Since after the screening process, the number of defective items at time, t1, is αQ, the
effective inventory level at t = t1 after removing the defective items is given by:
D
Ieff (t1 ) = Q e−θ t1 + ⎡e −θ t1
−1⎤⎦ − α Q (5)
θ ⎣
Further, the solution of the differential equation (2) along with the boundary condition, at
t = t1, I(t) = Ieff(t1) is:
D
I 2 (t ) = Q e −θ t + ⎡e −θ t
− 1⎤⎦ − α Q, t1 ≤ t ≤ T (6)
θ ⎣
Now, we know that t = T , I 2 (T ) = 0 . Thus, equation (6) reduces to

D(eθ T − 1)
Q= (7)
θ (1 − α eθ T )
Further, in order to avoid shortages during the screening time (t1), the effective
percentage, α (which is a random variable uniformly distributed in the range [a, b], where
0 < a < b < 1), is restricted to:
D
(1 − α ) Q ≥ D t1 ⇒ α ≤ 1 − (8)
λ
where
Q
t1 = . (9)
λ
Since the present model has been developed under the condition of permissible delay in
payments, for calculating interest earned and interest payable, there may be three distinct
cases, viz.:
1 M ≤ t1 ≤ T

2 t1 ≤ M ≤ T

3 t1 ≤ T ≤ M

The retailer’s total profit during a cycle for all the three cases, π j (T ), j = 1, 2,3 , is
consisted of the following:
π j (T ) = Sales revenue − Ordering cost − Purchasing cost − Screening cost
(10)
− Holding cost + Interest earned − Interest paid

Furthermore, the present model has been developed under inflationary conditions. Thus,
by using continuous compounding of inflation and discount rate, the present worth of the
various costs is evaluated as follows:
 Credit financing for deteriorating imperfect-quality items 299

1 Present worth of the total sales revenue, SR, is divided into two parts, i.e., the sum of
the revenue generated by the demand meet during the time period (0, T), SR1, and
sale of imperfect-quality items, SR2
T pD
SR1 = ∫ pDe − Rt dt = ⎡1 − e − RT ⎤⎦
0 R ⎣
SR2 = psα Qe− Rt1

Hence, the present worth of the total sales revenue is:

pD
SR = SR1 + SR2 = ⎡1 − e − RT ⎤⎦ + psα Qe − Rt1 (11)
R ⎣
2 Present worth of ordering cost = A (12)
3 Present worth of purchase cost = c Q (13)
(Since ordering and purchase costs are calculated at time t = 0, the inflation does not
affect the same.)
4 Present worth of screening cost = βQ (14)
(Since the screening is over at time t1 <<< T, the inflation does not affect the
screening cost.)
5 Present worth of holding cost, Ch, for the replenishment cycle using equations (4)
and (6) is:

⎡ t1 T ⎤
Ch = h ⎢ ∫ I1 (t )e − Rt dt + ∫ I 2 (t )e − Rt dt ⎥
⎣⎢ 0 t1 ⎦⎥ (15)
hQ hD ⎡1 − e − (θ + R )T e − RT − 1 ⎤ hα Q − RT
= ⎡⎣1 − e − (θ + R )T ⎤⎦ + + ⎥+ ⎡ e − e − Rt1 ⎤⎦
(θ + R ) θ ⎢⎣ (θ + R ) R ⎦ R ⎣

where

Q D ( eθ T − 1)
t1 = ,Q= .
λ θ (1 − α eθ T )

Since there are three distinct cases, the interest earned and the interest paid are calculated
for each case separately.
Case 1: M ≤ t1 ≤ T

In this case, the retailer deposits the accumulated revenue from cash sales during the
period (0, M) and earns an interest rate of Ie. At M the accounts have to be settled; it is
assumed that accounts will be settled by proceeds of sales generated up to M and by
taking a short-term loan at an interest rate of Ip for the duration of (T–M) for financing
the unsold stock.
300 C.K. Jaggi, A. Khanna and M. Mittal

Consequently, the present worth of interest earned, CI e1 , for the replenishment cycle is:
M
⎡1 − e − RM Me − RM ⎤
CI e1 = pI e ∫ Dte − Rt dt = pI e D ⎢ 2
− ⎥ (16)
0 ⎣ R R ⎦
And the present worth of interest payable, CI p1 , using equations (4) and (6) is:

⎡ t1 T ⎤
CI p1 = cI p ⎢ ∫ I1 (t )e − Rt dt + ∫ I 2 (t )e − Rt dt ⎥
⎢⎣ M t1 ⎥⎦
⎡ Q D ⎡ e− (θ + R ) M − e − (θ + R )T e − RT − e − RM ⎤⎤ (17)
⎢ ⎡⎣e− (θ + R ) M − e − (θ + R )T ⎤⎦ + ⎢ + ⎥⎥
(θ + R ) θ ⎣ (θ + R) R ⎦⎥
CI p1 = cI p ⎢
⎢ α Q − RT ⎥
⎢+ ⎡e − e− Rt1 ⎤⎦ ⎥
⎣ R ⎣ ⎦
Substituting the values from equations (11) to (17) into equation (10), the present worth
of total profit, π 1 (T ) , becomes:
⎡ pD ⎡ 1 − e − RM M e − RM ⎤⎤
π 1 (T ) = ⎢ ⎡⎣1 − e − RT ⎤⎦ + p sα Q e − Rt1 + pI e D ⎢ 2
− ⎥⎥
⎣ R ⎣ R R ⎦⎦
⎡ ⎤
(18)
hQ hD ⎡ 1 − e − (θ + R )T e − RT − 1 ⎤ hα Q − RT
⎢ A + cQ + β Q + ⎡⎣1 − e − (θ + R )T ⎤⎦ + ⎢ + ⎥+ ⎡⎣ e − e − Rt1 ⎤⎦ ⎥
⎢ (θ + R ) θ ⎣ (θ + R ) R ⎦ R ⎥
−⎢
⎢ cI ⎡⎢ Q ⎡ e − (θ + R ) M − e − (θ + R )T ⎤ + D ⎡ e
− (θ + R ) M
− e − (θ + R )T e − RT − e − RM ⎤ α Q − RT ⎤ ⎥⎥
⎦ θ ⎢ + ⎥+ ⎡e − e ⎤⎦ ⎥
− Rt1
⎢ p ⎣ (θ + R ) ⎣ ⎣ (θ + R ) R ⎦ R ⎣ ⎦ ⎥⎦
⎣
Since α is a random variable with known probability density function, f (α ) , the
expected total profit is E [ π 1 (T )] . Equation (18) reduces to:
⎡ ⎡ pD ⎡1 − e− RM Me− RM ⎤ ⎤ ⎤
⎢⎢ ⎡1 − e− RT ⎦⎤ + ps E[α ]Qe− Rt1 + pI e D ⎢
⎣ 2
− ⎥⎥ ⎥
⎢⎣ R ⎣ R R ⎦ ⎦ ⎥
⎢ ⎥ (19)
⎢ ⎡ hQ hD ⎡1 − e−(θ + R )T e− RT − 1⎤ hE[α ]Q − RT − Rt1 ⎤⎥
E[π1 (T )] = ⎢ A + cQ + β Q + ⎡⎣1 − e − (θ + R )T
⎤⎦ + + + ⎡ e − e ⎤ ⎥
⎢ (θ + R ) θ ⎣⎢ (θ + R) R ⎦
⎥
R ⎣ ⎦ ⎥
⎢− ⎢ ⎥⎥
⎢ ⎢ ⎥
⎡ Q D ⎡e − (θ + R ) M
−e − (θ + R ) T −
e −e
RT − RM
⎤ E[α ]Q − RT − Rt1 ⎤ ⎥ ⎥
⎢ ⎢cI p ⎢ ⎡⎣e− (θ + R ) M − e− (θ + R )T ⎤⎦ + ⎢ + ⎥+ ⎡e − e ⎦⎤ ⎥ ⎥
⎢⎣ ⎢⎣ ⎣ (θ + R) θ ⎣ (θ + R) R ⎦ R ⎣ ⎦ ⎥⎦ ⎥⎦
θT
where t1 = Q and Q = D(e − 1)θ T .
λ θ (1 − E[α ]e )
The optimal value of T = T1 (say), which maximises E[π 1 (T )] , can be obtained by
d E [π 1 (T )]
solving the equation, = 0 , which gives
dT
⎡ pD −RT ⎤
⎢ R (Re ) + ps E[α](Xe −QRe Y)⎥
−Rt1 −Rt1

⎣ ⎦
⎡ hX hD hE[α]X −RT −Rt1 ⎤
⎢cX +β X + ⎡⎣1−e−(θ+R)T ⎤⎦ +hQe−(θ+R)T + ⎡⎣e−(θ+R)T −e−RT ⎤⎦ + ⎡⎣e −e ⎤⎦ ⎥ (20)
⎢ (θ + R) θ R ⎥
−⎢⎢+hE[α]Q⎡⎣e−Rt1Y −e−RT ⎤⎦ ⎥ =0
⎥
⎢ ⎥
⎢+CIp ⎢Qe−(θ+R)T + X ⎡e−(θ+R)M −e−(θ+R)T ⎤ + D⎡e−(θ+R)T −e−RT ⎤+ E[α]X ⎡e−RT −e−Rt1 ⎤⎥ + E[α]Q⎡e−Rt1Y −e−RT ⎤⎥
⎡ ⎤
⎢⎣ (θ + R) ⎣ ⎦ θ ⎣ ⎦ R ⎣ ⎦ ⎣ ⎦⎥⎦
⎣ ⎦
 Credit financing for deteriorating imperfect-quality items 301

d 2 E[π 1 (T )]
provided ≤0
dT 2
θT dt1 Deθ T (1 − E[α ])
where X = dQ = Q′ = De (1 − Eθ[Tα ]) and Y = == .
dT (1 − E[α ]e ) 2 dT λ (1 − E[α ]eθ T ) 2
Case 2: t1 ≤ M ≤ T
In this case, the retailer can earn interest on revenue generated from the sales up to M,
and also during the period (t1, M) he earns interest on the revenue generated by the sale of
defective items at t1. Although he has to settle the account at M, for that, he has to
arrange money at some specified rate of interest in order to get his remaining stocks
financed for the period M–T.
Thus, the present worth of interest earned, CI e 2 , in this case is:
M

( ps I eα Q )( M − t1 )
− Rt1
CI e 2 = pI e ∫ Dte − Rt dt + e
0
(21)
⎡1 − e − RM Me − RM ⎤ − Rt1
= pI e D ⎢ 2
− ⎥ + e ( ps I eα Q )( M − t1 )
⎣ R R ⎦
And the present worth of interest payable, CI p 2 , for the replenishment cycle using
equation (6) is:
T
CI p2 = cI p ∫ I2 (t)e−Rt dt
M
(22)
⎡ Q D ⎡e−(θ +R)M − e−(θ +R)T e−RT − e−RM ⎤ αQ −RT −RM ⎤
= cI p ⎢ ⎡⎣e−(θ +R)M − e−(θ +R)T ⎤⎦ + ⎢ + ⎥ + ⎡⎣e − e ⎤⎦⎥
⎣(θ + R) θ⎣ (θ + R) R ⎦ R ⎦
Substituting the values from equations (11) to (15), (21) and (22) into equation (10), the
present worth of total profit, π 2 (T ) , becomes:
⎡ pD ⎡1 − e− RM Me− RM ⎤ − Rt1 ⎤
π 2 (T ) = ⎢ ⎡⎣1 − e− RT ⎤⎦ + psα Qe− Rt1 + pI e D ⎢ 2
− ⎥ + e ( ps I eα Q )( M − t1 ) ⎥
⎣ R ⎣ R R ⎦ ⎦
⎡ hQ hD ⎡1 − e− (θ + R )T e− RT − 1⎤ hα Q − RT − Rt1 ⎤ (23)
⎢ A + cQ + β Q + ⎡⎣1 − e−(θ + R )T ⎤⎦ + + ⎥+ ⎡e − e ⎤⎦ ⎥
⎢ (θ + R ) θ ⎢⎣ (θ + R) R ⎦ R ⎣ ⎥
−⎢ ⎥
⎢CI ⎢⎡ Q ⎡e−(θ + R ) M − e−(θ + R )T ⎤ + D ⎡ e − e−(θ + R )T e− RT − e− RM ⎤ α Q − RT − RM ⎤
− (θ + R ) M
+ ⎡⎣e − e ⎤⎦ ⎥ ⎥
⎢ ⎣ ⎦ θ ⎢ ⎥+ ⎥
⎣ (θ + R) (θ + R)
p
⎣ ⎣ R ⎦ R ⎦ ⎦
Since α is a random variable with known probability density function, f (α ) , the
expected total profit is E [ π 2 (T )] . Equation (23) reduces to:
⎡ pD ⎡1 − e− RM Me−RM ⎤ − Rt1 ⎤
E[π 2 (T )] = ⎢ ⎡⎣1 − e− RT ⎤⎦ + ps E[α ]Qe−Rt1 + pIe D ⎢ 2
− ⎥ + e ( ps Ie E[α ]Q)( M − t1 ) ⎥
⎣ R ⎣ R R ⎦ ⎦
⎡ hQ hD ⎡1 − e−(θ + R)T e− RT −1⎤ hE[α ]Q − RT − Rt1 ⎤ (24)
⎢ A + cQ + β Q + ⎡⎣1 − e−(θ + R)T ⎤⎦ + ⎢ + ⎥+ ⎡⎣e − e ⎤⎦ ⎥
⎢ (θ + R ) θ ⎣ ( θ + R ) R ⎦ R ⎥
−⎢ ⎥
⎢CI ⎢ ⎡ Q D ⎡ e−(θ + R) M
− e−(θ + R )T
e− RT
− e− RM
⎤ E [α ]Q ⎤
⎡⎣e− (θ + R ) M
−e − (θ + R )T
⎤⎦ + ⎢ + ⎥ + ⎡⎣e − e ⎤⎦ ⎥ ⎥
− RT − RM
⎢ p
⎣ (θ + R) θ⎣ (θ + R) R ⎦ R ⎦ ⎥⎦
⎣
302 C.K. Jaggi, A. Khanna and M. Mittal

θT
where t1 = Q and Q = D(e − 1)θ T .
λ θ (1 − E[α ]e )

The optimal value of T = T2 (say), which maximises π 2 (T ) , can be obtained by solving

dE[π 2 (T )]
the equation, = 0 , which gives:
dT

⎡ pD −RT ⎤
⎢ R (Re ) + ps E[α](Xe −QRe Y) −Re Y ( ps IeE[α]Q)( M −t1 ) ⎥
−Rt1 −Rt1 −Rt1

⎢ −Rt ⎥
⎢⎣+e 1 ( ps Ie E[α]X )( M −t1 ) −e 1 ( ps Ie E[α]Q) Y
−Rt
⎥⎦
⎡ hX hD hE[α]X −RT −Rt1 ⎤
⎢cX + β X + ⎡⎣1−e−(θ +R)T ⎤⎦ + hQe−(θ +R)T + ⎡⎣e−(θ +R)T −e−RT ⎤⎦ + ⎡⎣e −e ⎤⎦ ⎥
⎢ (θ + R) θ R ⎥
−⎢⎢+hE[α]Q⎡⎣e−Rt1Y −e−RT ⎤⎦ ⎥ = 0 (25)
⎥
⎢ ⎡ −(θ +R)T X D E[α ]X ⎤ ⎥
⎢+CI p ⎢Qe + ⎡⎣e−(θ +R)M −e−(θ +R)T ⎤⎦ + ⎡⎣e−(θ +R)T −e−RT ⎤⎦ + ⎡⎣e−RT −e−RM1 ⎤⎦⎥ + E[α]Q⎡⎣−e−RT ⎤⎦ ⎥
⎣⎢ ⎣ (θ + R) θ R ⎦ ⎥⎦

d 2 E[π 2 (T )]
provided ≤0
dT 2
θT dt Deθ T (1 − E[α ])
where X = dQ = Q′ = De (1 − Eθ[Tα ]) and Y = 1 == .
dT (1 − E[α ]e ) 2
dT λ (1 − E[α ]eθ T ) 2
Case 3: t1 ≤ T ≤ M

In this case the credit period M is more or equal to the cycle T, so the retailer earns
interest on cash sales during the period (0, M) and pays no interest for the items kept in
stock. Hence, the present worth of the interest earned, CI e 3 , is:
T T
CI e 3 = pI e ∫ Dte − Rt dt + ( M − T )e − RT ∫ Ddt + ps I eα Q( M − t1 )e − Rt1
0 0
(26)
⎡1 − e − RT Te − RT ⎤
⎥ + pI e ( M − T ) DTe + ps I eα Q ( M − t1 )e
− RT − Rt1
= pI e D ⎢ 2
−
⎣ R R ⎦
Substituting the values from equations (11) to (15) and (26) into equation (10), the
present worth of total profit, π 3 (T ) , becomes

⎡ pD ⎡1 − e− RT Te− RT ⎤ ⎤
⎢ ⎡⎣(1 − e− RT )⎤⎦ + psαQe− Rt1 + pIe D ⎢ − − RT
⎥ + pIe (M − T )DTe ⎥
π 3 (T ) = ⎢ R ⎣ R 2
R ⎦ ⎥
⎢+ p I α Q(M − t )e− Rt1 ⎥ (27)
⎣ s e 1 ⎦
⎡ hQ hD ⎡1 − e−(θ + R)T e− RT −1⎤ hαQ − RT − Rt1 ⎤
− ⎢ A + cQ + β Q + ⎡1 − e−(θ + R)T ⎦⎤ + + ⎥+ ⎡e − e ⎤⎦ ⎥
⎣⎢ (θ + R) ⎣ θ ⎢⎣ (θ + R) R ⎦ R ⎣ ⎦⎥
 Credit financing for deteriorating imperfect-quality items 303

Since α is a random variable with known probability density function, f (α ) , the

expected total profit is E [ π 3 (T )] . Equation (27) reduces to:

⎡ pD ⎡1− e−RT Te−RT ⎤ ⎤

⎢ ⎡⎣1− e−RT ⎤⎦ + ps E[α]Qe−Rt1 + pIe D ⎢ 2 − ⎥ +⎥
E[π3 (T )] = ⎢ R ⎣ R R ⎦ ⎥
⎢ pI (M − T )DTe −RT + p I E[α]Q(M − t )e−Rt1 ⎥ (28)
⎣ e s e 1 ⎦
⎡ hQ hD ⎡1− e−(θ +R)T e−RT −1⎤ hE[α]Q −RT −Rt1 ⎤
− ⎢ A + cQ + βQ + ⎡⎣1− e−(θ +R)T ⎤⎦ + ⎢ + ⎥+ ⎡e − e ⎤⎦⎥
⎢⎣ (θ + R) θ ⎣ (θ + R) R ⎦ R ⎣ ⎥⎦

Q D(eθ T − 1) .
where t1 = and Q =
λ θ (1 − E[α ]eθ T )
The optimal value of T = T3 (say), which maximises, π 3 (T ) , can be obtained by
dE[π 3 (T )]
solving = 0 , which gives:
dT

⎡ pD −RT ⎡ −e−RT ⎤ ⎤
⎢ (Re ) + ps E[α]( Xe 1 −QRe 1 Y) + pIe D⎢
−Rt −Rt
+Te−RT ⎥ − pIe DTe −RT + pIe (M −T)De −RT ⎥
⎢R ⎣ R ⎦ ⎥
⎢−RpI (M −T)DTe −RT −Re−Rt1 Y ( p I E[α]Q)( M −t ) + e−Rt1 ( p I E[α]X )( M −t ) − e−Rt1 ( p I E[α]Q) Y ⎥
⎣ e s e 1 s e 1 s e ⎦ (29)
⎡ hX −(θ +R)T hD hE[α]X −RT −Rt1 ⎤
⎢cX + β X + (θ + R) ⎡⎣1− e ⎤⎦ + hQe−(θ +R)T + ⎣⎡e−(θ +R)T − e−RT ⎦⎤ + ⎡e − e ⎦⎤⎥
−⎢ θ R ⎣
⎥ =0
⎢+hE[α]Q⎡e−Rt1Y − e−RT ⎤ ⎥
⎣ ⎣ ⎦ ⎦

d 2 E[π 3 (T )]
provided ≤0
dT 2
θT dt1 Deθ T (1 − E[α ])
where X = dQ = Q′ = De (1 − Eθ[Tα ]) and Y = == .
dT (1 − E[α ]e ) 2 dT λ (1 − E[α ]eθ T ) 2
Now, expected total profit at T = M, E[π ( M )] , is given by:

⎡ pD ⎡1− e−RM Me−RM ⎤⎤

⎢ ⎡⎣1− e ⎤⎦ + ps E[α]Qe 1 + pIe D ⎢
−RM −Rt
− ⎥⎥
E[π (M)] = ⎢ R ⎣ R
2
R ⎦⎥
⎢+ p I E[α]Q(M − t )e−Rt1 ⎥ (30)
⎣ se 1 ⎦
⎡ hQ hD ⎡1− e−(θ +R)M e−RM −1⎤ hE[α]Q −RM −Rt1 ⎤
− ⎢ A + cQ + βQ + ⎡⎣1− e−(θ +R)M ⎤⎦ + ⎢ + ⎥+ ⎡e − e ⎤⎦⎥
⎣⎢ (θ + R) θ ⎣ (θ + R) R ⎦ R ⎣ ⎦⎥

4 Solution procedure

Further, the derivatives of expected total profit functions, E[π J (T )], j =1, 2,3 , are
complicated, and it is very difficult to prove concavity mathematically. Therefore, the
304 C.K. Jaggi, A. Khanna and M. Mittal

same has been assumed. Moreover, the nature of the functions has been demonstrated
graphically (Figure 2) with few distinct datasets, as stated below:
Cost High High
Demand High Low
Cost Low Low
Demand High Low

Figure 2 Concavity of the expected total profit function

Concavity for high cost and high demand

Concavity for high cost and low demand

1030000

4900000

980000

4700000
E x p e c te d to ta l p r o fit

E x p e c te d to ta l p r o fit

930000
4500000
Expected Total Profit

880000
4300000

830000
4100000

780000
3900000
0.5 1 1.5 2 2.5 3 3.5
0.5 1 1.5 2 2.5 3 3.5
T
T

Concavity for Low cost and high demand Concavity for Low cost and low demand

390000 70000

380000

370000 65000

360000
E x p e c te d to ta l P ro fit

E x p e c t e d t o t a l p r o f it

350000 60000

340000

330000 55000

320000

310000 50000

300000

290000 45000
0.1 0.3 0.5 0.7 0.9 1.1 1.3 1.5 1.7 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6
T T

In order to find the optimal value T, the following algorithm is proposed:

 Credit financing for deteriorating imperfect-quality items 305

Algorithm
Step 1. Determine the values of T (i.e. T1* ) using equation (20). Now using the value
of T, calculate the values of Q and t1 from equations (7) and (9), respectively.
If M < t1 < T1
then the cycle length will be T1* and the value of profit E[π1 (T1 )] can
be obtained by substituting T1* in equation (19),
else this case is not feasible and set E[π1 (T1 )] = 0 .
Step 2. Determine the values of T (i.e. T2* ) using equation (25). Now using the value
of T, calculate the values of Q and t1 from equations (7) and (9), respectively.
If t1 < M < T2
then the cycle length will be T2* and the value of profit E[π 2 (T2 )]
can be obtained by substituting T2* in equation (24),
else this case is not feasible and set E[π 2 (T2 )] = 0 .
Step 3. Determine the values of T (i.e. T3* ) using equation (29). Now using the value
of T, calculate the values of Q and t1 from equations (7) and (9), respectively.
If t1 < T3 < M
then the cycle length will be T3* and the value of profit E[π 3 (T3 )] can
be obtained by substituting T3* in equation (28),
else this case is not feasible and set E [π 3 (T3 ) = 0] .
Step 4. Determine the profit at T = M, i.e., E[π ( M )] from equation (30).
Step 5. Compare the expected total profit for cases 1, 2, 3 and at M i.e.
Max { E[π 1 (T1 )], E[π 2 (T2 )], E[π 3 (T3 )], E[π ( M )]}

Select the case which is having maximum expected total profit and
corresponding optimal values of Q and t1.

5 Numerical example

The model has been validated with the following data, D = 50,000 units/year,
A = 100/cycle, h = $5/unit/year, λ = 175,200 units/year, c = $25/unit, p = $40/unit,
ps = $10/unit, β = $0.5/unit, R = 0.06 and θ = 0.1, M = 0.15 year and percentage
defective random variable α with its pdf,
⎧ 25, 0 ≤ α ≤ 0.04
f (α ) = ⎨ , E[α ] = 0.02 .
⎩0, otherwise

First of all, we check the condition on α given by equation (8) for the given data which
ensures the shortages are not there during the screening process, i.e. α ≤ 0.715 .
Using the proposed algorithm, results are obtained as: cycle length, T* = 1.04 year,
Q* = 55,927, t1* = 0.32 year and E [π (T *)] = $385,818.
306 C.K. Jaggi, A. Khanna and M. Mittal

Also for the case when M = 0: T* = 0.99 year, Q* = 53,473, t1* = 0.31 year and
E [π (T *)] = $355,267.
Thus, results suggest that it is beneficial for the retailer to go for permissible delay in
payments under inflationary conditions.

6 Sensitivity analysis

In this section we perform the sensitivity analysis on the key parameters to look into
the robustness of the model, i.e., inflation (R), permissible delay in payment (M),
deterioration (θ) and expected number of imperfect-quality items (E[α]) in order to
study their effect on the optimal replenishment policy. The results are summarised in
Tables 1–3.
Table 1 Effects of changing R and M on the optimal replenishment policy

M Q t1 T Expected profit
0.15 53,359 0.3 0.99 367,570

R = 0.08 0.30 55,671 0.32 1.03 397,503

0.45 57,966 0.33 1.07 427,879

M Q t1 T Expected profit
0.15 55,927 0.32 1.04 385,818

R = 0.06 0.30 58,351 0.33 1.08 417,310

0.45 60,802 0.35 1.12 449,398

M Q t1 T Expected profit
0.15 59,045 0.33 1.09 406,037

R = 0.04 0.30 61,609 0.34 1.14 439,299

0.45 64,115 0.36 1.18 473,205

Table 2 Effects of changing θ on the optimal replenishment policy

θ Q t1 T Expected profit % Change in expected profit

0.025 65,603 0.37 1.26 463,242 +20.07
0.050 62,030 0.35 1.18 434,190 +12.54
0.075 58,822 0.34 1.1 408,575 +05.90
0.100 55,927 0.32 1.04 385,818 Base
0.125 53,302 0.3 0.98 365,466 –05.28
0.150 50,911 0.29 0.93 347,154 –10.02
0.175 48,724 0.28 0.88 330,591 –14.31
 Credit financing for deteriorating imperfect-quality items 307

Table 3 Effects of changing E[α] on the optimal replenishment policy

E[α] Q T1 T Expected profit % Change in expected profit

0.010 56,549 0.32 1.06 397,951 +3.14
0.015 56,240 0.32 1.05 391,879 +1.57
0.020 55,927 0.32 1.04 385,818 Base
0.025 55,610 0.32 1.03 379,769 –1.57
0.030 55,288 0.32 1.02 373,733 –3.13

6.1 Observations
1 Table 1 shows that when the permissible delay (M) increases from 0.15 to 0.30, there
is increase in cycle length (T) and order quantity (Q) by 4%, whereas expected total
profit increases by 8.25%. Larger delay period helps the retailer to prolong the
payments to the supplier without penalty, which indirectly reduces the costs incurred
by the retailer and eventually results in higher profits. Hence, the retailer should
always ask for long credit periods from the supplier in order to increase his profits.
2 Moreover from Table 1, we can see that when the net discount rate of inflation (R)
decreases from 0.08 to 0.04 (i.e. inflation rate increases), the optimal order quantity
and expected total profit increase by 10.5%. As under inflationary conditions the
price of goods increases, the retailer would like to order large quantity for a longer
period of time and hence profits increase.
3 In Table 2, as the deterioration rate (θ) decreases/increases by (0.100–0.025/0.100–
0.175), the expected total profit increases/decreases by 20.07%/14.31%. Since due to
deterioration the utility of the goods decreases, it is optimal for the retailer to order
for a shorter period of time so as to manage the loss due to deterioration.
4 Table 3 illustrates that as the expected number of imperfect-quality items ( E[α ] )
decreases/increases by (0.020–0.010/0.020–0.030), the expected total profit increases/
decreases by 3.14%/3.13%. It indicates that the number of defective items directly
affects the revenue; hence the retailer should take appropriate corrective/preventive
measures to ensure that the ordered lot does not contain a high percentage of
defective items.

7 Conclusion

In the present paper, a profit-maximising imperfect-quality inventory model has been

developed incorporating two interesting phenomena, viz. inflation and deterioration, in
the presence of trade credit. As every production process is inherited with some chance
cause of variation, a screening process is inevitable in order to ensure the items sold are
of good quality. Here, screening rate is assumed to be more than the demand rate, which
enables the retailer to fulfil the demand, out of the products which are found to be of
perfect quality, along with the screening process. Furthermore, since inflation and
deterioration are having push-and-pull effect on the optimal cycle length, their impact
while formulating the inventory model cannot be ignored. Moreover, in this inflation
308 C.K. Jaggi, A. Khanna and M. Mittal

regime, trade credit has also been proved as an essential tool for financial growth in
many businesses, as it serves as a good incentive policy for the buyers, and inflation
suggests one to procure more, which means more investment in inventory, which is
highly correlated with the return on investment. Hence, it is important to consider the
effects of inflation and time value of money in formulating inventory replenishment
policy for deteriorating imperfect-quality items with trade credit. Such a situation is very
much prevalent in big retail establishments in developing countries, which deal in
electronic components, domestic goods and other consumer products.
Lastly, a numerical example has been solved to validate the results obtained, and
sensitivity analysis has been carried out on different parameters of the system. The
findings provide important managerial insights to the retailers for deciding the
appropriate ordering policy under varying situations, viz. (a) when the number of
defective items increases in the ordered lot, then the retailer should be more vigilant
while ordering, (b) for highly deteriorating items the retailer should order more
frequently, (c) in the highly inflationary market, the retailer should order a large quantity
so as to increase his profits, and (d) when the permissible delay period is large then the
retailer is encouraged to give a big order, which eventually results in higher profits. For
future study, it is desirable to extend the proposed model for linearly increasing and
stock-dependent demand with or without shortages.

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