A synopsis on

“Estimates of inventory demand by Nepalese corporation”, by Prof. Dr. Radhe Shyam Pradhan
Buddha Academic Publishers and Distributors Pvt.Ltd Second edition, 2006, pp 185-193
Seminar by MBA (II) (Finance), Uniglobe College
Date: 27/03/2017
Presented by: Group “C” 2nd Trimester Hema Bista, Hemlata Chand, Ishwor Chaudhary, Jagannath Neupane, Jhalak Man
Budha, Jyoti Khadha, and Kamana Khand Thakuri
Author’s Details:
Dr.Radhe S. Pradhan, Professor of central department of management, Tribhuwan University Nepal received his master’s degree in
business administration and commerce in 1975. He received PH.D degree from the University of Delhi, India in 1986. He has also
severed as visiting Fulbright faculty to the college of business, Florida State University, Tallahassee, Florida USA from August
1992 to January 1993.
Research context
This paper examines the transaction demand for inventory equations so as to investigate whether transactions inventory balance
vary proportionately or less than in proportion to changes in the volume of sales. It also investigates the data of capital cost on
inventory holding of corporations. By using the data of manufacturing public corporation of Nepal, the study presents some
empirical evidence showing the economics of scale in inventory holdings, significant effect of capital cost on inventory demand,
and the slow speed of adjustment between actual and desired level of inventories.
Statement of problem
This study deals with the following issue in the context of manufacturing public corporation Nepal:
1. What controversy arises as to the presence of economies of scale in inventory holding?
2. What factors affects in inventory demand?
3. What controversy arise as to the adjustment speed of actual inventory level with target inventory level?
Objective of the study
The major objective of the study is
1. To examine the cost of capital effect on inventory demand.
2. To describe the models that attempt to describe the firms demand for inventories.
3. To test the empirical evidence in support of the presence of economies of scale in inventory holdings, significant effect of
capital costs on inventory investment, and slow speed of adjustment between actual and desired levels of inventories.
Significance of the study
There are several studies that have been conducted on the cost of capital effect on inventory demand in Nepalese corporation but
this type of research is very few in Nepal. Moreover, the study is significant to investigate whether transactions inventory balance
vary proportionately or less than in proportion to changes in the volume of sales. It also investigates the data of capital cost on
inventory holding of corporations. By using the data of manufacturing public corporation of Nepal.
Literature review
There is no controversy as to the fact that target inventory level is a function of expected sales as indicated by almost all the earlier
studies on the demand for inventories by firms. The controversy arises as to the presence of economies of scale in inventory holdings,
the cost of capital and other effects on inventory demand, and the adjustment speed of actual inventory level with target inventory
level. According to Irvine (1981 May, 1981 September) and Akhtar (1983) clearly indicated economies of scale in inventory holding
while some of the inventory demand function of Lieberman (1980) showed diseconomies of scale. Liu (1963, 1969), Kuznets (1964),
Lieberman, Irvin and Akhtar reported statistically significant effect of capital cost on the demand for inventories, while Robbins
(1981) did not report the same. Controversy also exist with respect to coefficient of adjustments. Among others, Burrrows, Maccini
and Rossana and Irvine observed faster adjustment between actual inventories and targeted inventories. While Lovell and Grossman
(1973) observed slow speed of adjustment. Thus here is no unanimous finding s with respect to the economies of scale in inventory
holdings, the capital cost effect on inventory demand and the adjustment coefficient of actual inventories to desire inventories. It
has therefore become difficult to support one view or another as there exists no such studies in the context of manufacturing public
corporations of Nepal.
Research Hypothesis
Based on the objectives of the study, the following hypothesis have been formulated and tested. H1: There is significant relationship
between sales coefficient and prior expected sign. H2: There is significant relationship between fluctuation in inventory level and
fluctuation in financial carrying cost of industry. H3: There is negative relationship between inventory demand and capacity
utilization. H4: There is no significant relationship between coefficient of capacity utilization and their sign are as expected. H5:
There is no significant relationship between actual level of inventory and desired level of inventory.
Research methodology
The study is based on the secondary data, which were gathered for nine manufacturing public corporation for 12 years from 1973
to 1984. The nine selected corporations are Agriculture Tools, Factory, Brick and Tile factory, Balaju Textiles Ltd., Dairy
Development Corporations and Royal Drug Limited. Similarly the financial data on inventories and other related variable used in
this paper have been collected mostly from the official annuals reports brought out by the "Office of the Auditor General",
Government of Nepal (G/N). Besides, the information has also been supplemented from "Quarterly Economic Bulletin" published
by the Central Bank of Nepal i.e. Nepal Rastra Bank, "Profiles of public enterprises in Nepal" published by the Corporation
Coordination Council, and "The Economic Survey " published by the Ministry of Finance. The analysis is this study also contained
comparison of the findings of the study with the earlier studies on the inventory demand by Nepalese’s Corporation.
Following modes are estimated for analyzing the effect of cost of capital in inventory demand.
Model 1: RIS (Y*) = b0 +b1 in S+ b2 in S + Ui
Model 2: RISC (Y*) = b0 +b1 in S+ b2 in S + Ui
Where,
RIS= the regression of inventories on sales produced, RISC= the regression of inventories on sales and capital cost produced, Y*=
desired level of inventory, S= the real desired wealth defined in terms of sales, I= the holding cost, b0= the constant, b1 & b 2= the
elasticity's of Y with respect to sales and holding cost.
 Major Findings
The major conclusion indicated by this paper is the empirical evidence to support of the presence of economies of scale in inventory
holdings, significant effect of capital cost on inventory investment , and slow speed of adjustments between actual and desired level
of inventories. This empirical result shows that the sales coefficient is significant with a priori expected sign. The elasticity of sales
with respect to inventories is less than unity. It thus supports the findings of Akhtar and Irvine and contradicts unitary or more than
unitary sales elasticity’s noticed some of the equations of Lieberman. It all shows the evidence of economics of scale with respect
to the demand for inventories by manufacturing public corporation of Nepal.
It also shows that fluctuation in inventory level depend in a statistically significant manner on fluctuations in financial carrying cost
of inventories. This finding supports the conclusion of Liu, Kuznets, Lieberman, Irvine and Akhtar, and contradicts the results of
Robinson, Lovell, Jon Joyce and Rossana as far as the effect of capital cost on inventory demand is concerned. In equation (10).
Reveals some further facts. Holding the sales constant, it indicate that a one percentage point increase in capital cost leads on an
average to about a 0.68 percent decline in inventory investment. Similarly holding cost 0.65 percent. Which is constant in inventory
investment. It provides an interest rate coefficient that is statically significance with a theoretically correct sign. Previously, this
coefficient is used to be either positive or not significant in many of the studies on the demand for inventories by firms. The highly
significant coefficient of sales is consistently less then unity in equation (10). It provides further evidence suggesting economics of
scale in inventory holdings.
In equation (13), the coefficient of the lagged dependent variable has been observed to be 0.85. Since the coefficient of lag Yt is
equal to 1 minus the adjustment coefficient (1-φ), the adjustment coefficient is equal to 0.15. The speed of adjustment between
desired and actual inventories as implied by this value is much slower. It seems that only 15 percent of the adjustment, of actual to
desired inventory levels is completed within a year. The result therefore contradicts the high speed of adjustment observed by
Burrows, Maccini and Rossana and Irivine. It is often argues that capacity utilization affects the demand for inventories by firms.
So this relation has been postulated to be negative as businesses tend to smooth out the pattern of production in order to avoid or
minimize the loss of efficiency. As this will result to resume inventory stock rather than to make production changes to meet current
demand, while at low capacity utilization levels, they will tend to build up stocks to avoid further cuts in production. And the
production level of the firm’s shows the positive relationship, as firms rise sufficiently close to capacity, inventories may be reduced
as finished goods are reduces below normal levels in response to growing and unfilled orders. And over all these let to hypothesize
a negative relationship between inventory demand and capacity utilization. But as per the equation no 14 and 15 the coefficient of
capacity utilization are not significant though their signs are as expected. We have found the coeffiecint of interest rate have gone
insignificant with the inclusion of capacity utilization variable . Even the overall fit and explanatory power of capacity utilization
model has shown poor performance. Thus the inclusion of capacity utilization variable in the model has not contributed much to the
demand for inventory function. It all indicated that capacity utilization as a significant variable affecting the demand for inventories
is questionable. Similarly if production levels of firms rise sufficiently close to capacity, inventories may be reduced as finished
goods are reduced below normal level in response to growing and unfilled orders (Lieberman). All these led to hypothesis a negative
relationship between inventory demand and capacity utilization. However, this is in contrast with Lovell's and Darling's (1965) a
priori expectation hat the relationship will be positive.
In equation (14&15), The coefficient of capacity utilization are not significant thought their signs area as expected. Moreover, the
coefficients of interest rate have gone insignificant with the inclusion of capacity utilization variable. Besides, the overall fit and
explanatory power of the model have also gone poor. Thus, the inclusion of capacity utilization variable in the models has not
contributed much to the demand for inventory functions. It all indicates that capacity utilization as a significant variable affecting
the demand for inventories is doubtful.
Conclusions
This paper which has been investigated into various issues in the context of manufacturing public corporations of Nepal has the
major conclusion shows the presence of economies of scale with respect to the demand for inventories. The result thus support the
findings of Irvine and Akhtar and contradicts the unitary or more than unitary scales elasticity’s observed in some of the equation
of Lieberman. The result of this study suggest strongly that the demand for inventories by corporation in a function of both sales as
well as their holding costs. The interest rate coefficient is statistically significant with a theoretically correct sign. This finding is
thus consistent with the finding of LIu, Kuznets, Lieberman, Irvine and Akhtar, and contradicts the results of Robinson, Lovell, Jon
Joyce Barrows and Maccini and Rossana. The adjustment speed of actual to desired levels of inventories has been observed to be
much slower, this finding contradicts the high speed of adjustment observed by Burrows, Irvine and Maccini and Rossana. It seems
to have not contributed much to the demand function of inventories. Similarly the earlier studies concerning the demand for
inventories by firms did not report unanimous findings. A lot of controversies exist with respect to the presence of economics of
scale in inventory holdings, effect of capital costs and capacity utilization rates on inventory demand, and the speed with which
actual inventories are adjusted to desired inventories. This paper has investigated these various issues in the context of manufacturing
public corporation of Nepal.
The adjustment speed of actual to desired levels of inventories has been observed to be much slower. This finding contradicts the
high speed of adjustment observed by Burrows, Irvine, and Maccini and Rossana.
Recommendations
The study found that the inclusion of capacity utilization variable in the model seems to have not contributed much to the demand
function of inventories. Thus, the capacity utilization as a significant variable affecting the demand for inventories in doubtful.
While putting the inventory in corporation we have to see sales as well as their holding cost. Then it will help to demand inventories
in your corporation. To manage the inventory level at Manufacturing Corporation we have to use economic re-order quantity
method. It will helps to identify at what level we have to order our goods.
Future scopes
The result of the study is based on the secondary data of the manufacturing corporation of Nepal. Thus, the future study may include
other manufactories sector such as sugar industry, noodles industry, food industry and plastic industry. The study can also be done
by using both primary data and secondary data to make the study more reliable and valid. Further the study can be conducted by
considering other capacity utilization variable such as operations and production management to calculate the average marginal cost
of production, the split between fixed and variable costs, inventory , manning, overtime costs, and engineering/maintenance costs.
The impact of this study will be useful tolls in developing more sophisticated techniques to evaluate the various regression model
for modern business. And this article can be helpful in future in findings on sales, interest rate and capacity utilization.