The Manufacturing Flexibility to Switch Products: Valuation and Optimal Strategy

Sorin Tuluca and Piotr Stalinski

No 292, Computing in Economics and Finance 2004 from Society for Computational Economics

Abstract: This paper applies a dynamic programming methodology to the valuation problem for the flexibility to switch. In our model, flexibility provides an investor with the right, or option, to perform a switch between a less profitable and a more profitable project at no cost. In contrast to previous analyses, the option to switch can be exercised in the future at any time during the decision horizon. We present the solution methodology that allows to determine the value of the flexibility and to identify the optimal timing of the switching decision. Comparative statics demonstrate how changes in the input parameters affect the values of the problem"s solution. The results partially explain why investing in flexible manufacturing systems is reported to have both low profitability and rate of diffusion.

Keywords: manufacturing flexibility; real option; capital budgeting (search for similar items in EconPapers)
JEL-codes: G13 G31 (search for similar items in EconPapers)
Date: 2004-08-11
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