How to escape a declining market: Capacity investment or exit?

Verena Hagspiel, Kuno Huisman, Peter Kort, Claudia Nunes

Research output: Contribution to journalArticleScientificpeer-review

Abstract

This paper considers a firm that faces a declining profit stream for its established product. The firm has the option to invest in a new technology with which it can produce an innovative product while having the option to exit at any point in time. In the presence of an exit option, earlier work determined the optimal timing to invest, where it was shown that higher uncertainty might accelerate investment timing. In the present paper the firm also decides on capacity. This extension leads to monotonicity, i.e. higher uncertainty delays investment timing. We also find that higher potential profitability of the innovative product market increases the incentive to invest earlier, where, however, we get the counterintuitive result that the firm invests in smaller capacity. Finally, if quantity has a smaller negative effect on price, the firm wants to acquire a larger capacity at a lower investment threshold.
Original languageEnglish
Pages (from-to)40-50
JournalEuropean Journal of Operational Research
Volume254
Issue number1
DOIs
Publication statusPublished - 2016

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Keywords

  • investment analysis
  • exit
  • capacity investment
  • declining market
  • real options

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