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Stepwise investment and capacity sizing under uncertainty

Chronopoulos, M., Hagspiel, V. and Fleten, S-K. (2017). Stepwise investment and capacity sizing under uncertainty. OR Spectrum, 39(2), pp. 447-472. doi: 10.1007/s00291-016-0460-0

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.

Publication Type: Article
Additional Information: This is a post-peer-review, pre-copyedit version of an article published in OR Spectrum. The final authenticated version is available online at: http://dx.doi.org/10.1007/s00291-016-0460-0
Publisher Keywords: Investment analysis, Capacity sizing, Flexibility, Real options
Subjects: H Social Sciences > HG Finance
Departments: Cass Business School > Actuarial Science & Insurance
URI: http://openaccess.city.ac.uk/id/eprint/21662
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