Investments in Lead-Time Reduction: How to Finance and How to Implement Available to Purchase

We consider a multi-period production problem in which a manufacturing firm produces a seasonal product to satisfy uncertain market demand in each selling period. The firm jointly determines the production quantity, working capital level, the amount of short-term debt, and dividends paid out to equity holders. It also has an option to raise capital by issuing long-term debt and invest in reducing lead times. Demand forecasts are updated according to a multiplicative martingale process. We formalize the problem by developing a Markov Decision Process (MDP) and characterize the structure of the optimal policy, which allows us to solve the problem in polynomial time. We show that debt (equity) financing is more beneficial for the products with low (high) demand uncertainty. Using our model, we propose a simple typology that shows effective investment strategies in reducing the lead time depending on demand uncertainty and the value added by production of each sub-component.