Cost of capital

The cost of capital is the opportunity cost of holding inventory in stock. It signifies the cost of foregone returns from investment that could have been earned, had capital not been tied up in holding inventory. The two main types of cost of capital arise from holding inventory at physical facilities and during transportation between network locations (in-transit).

The cost of capital (CC) is directly related to the average inventory quantity and can be calculated as

given the following assumptions:

• Average inventory is the calculated average inventory at a site for a given product
• Product value is the calculated standard cost of a given product
• Period time is the number of days the period lasts
• Inventory carrying cost % is the investment rate possible

Given the above formula, product value, period time, and inventory carrying cost % are fixed inputs to the equation. Average inventory can be calculated one of three ways: site inventory, in-transit inventory, and occupancy cost.