Stepwise investment and capacity sizing under uncertainty

Michail Chronopoulos (), Verena Hagspiel and Stein-Erik Fleten
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Michail Chronopoulos: University of Brighton
Verena Hagspiel: Norwegian University of Science and Technology

OR Spectrum: Quantitative Approaches in Management, 2017, vol. 39, issue 2, No 4, 447-472

Abstract: Abstract The relationship between uncertainty and managerial flexibility is particularly crucial in addressing capital projects. We consider a firm that can invest in a project in either a single (lumpy investment) or multiple stages (stepwise investment) under price uncertainty and has discretion over not only the time of investment but also the size of the project. We confirm that if the capacity of a project is fixed and the investment premium associated with stepwise investment is positive, then lumpy investment becomes more valuable than a stepwise investment strategy under high price uncertainty. By contrast, if a firm has discretion over capacity, then we show that the stepwise investment strategy always dominates that of lumpy investment. In addition, we show that the total amount of installed capacity under a stepwise investment strategy is always greater than that under lumpy investment.

Keywords: Investment analysis; Capacity sizing; Flexibility; Real options (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (12)

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Working Paper: Stepwise Investment and Capacity Sizing under Uncertainty (2015)
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DOI: 10.1007/s00291-016-0460-0

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