Uncertainty and stepwise investment

P.M. Kort, P. Murto, G. Pawlina

Research output: Contribution to journalArticleScientificpeer-review

Abstract

We analyze the optimal investment strategy of a firm that can complete a project either in one stage at a single freely chosen time point or in incremental steps at distinct time points. The presence of economies of scale gives rise to the following trade-off: lumpy investment has a lower total cost, but stepwise investment gives more flexibility by letting the firm choose the timing individually for each stage. Our main question is how uncertainty in market development affects this trade-off. The answer is unambiguous and in contrast with a conventional real-options intuition: higher uncertainty makes the single-stage investment more attractive relative to the more flexible stepwise investment strategy.
Original languageEnglish
Pages (from-to)196-203
JournalEuropean Journal of Operational Research
Volume202
Issue number1
Publication statusPublished - 2010

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Uncertainty
Trade-offs
Real Options
Optimal Investment
Timing
Choose
Flexibility
Distinct
Costs
Strategy
Business
Real options
Economies of scale
Market development
Investment strategy
Optimal investment strategy
Intuition
Lumpy investment
Incremental
Market

Cite this

Kort, P.M. ; Murto, P. ; Pawlina, G. / Uncertainty and stepwise investment. In: European Journal of Operational Research. 2010 ; Vol. 202, No. 1. pp. 196-203.
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Kort, PM, Murto, P & Pawlina, G 2010, 'Uncertainty and stepwise investment', European Journal of Operational Research, vol. 202, no. 1, pp. 196-203.

Uncertainty and stepwise investment. / Kort, P.M.; Murto, P.; Pawlina, G.

In: European Journal of Operational Research, Vol. 202, No. 1, 2010, p. 196-203.

Research output: Contribution to journalArticleScientificpeer-review

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T1 - Uncertainty and stepwise investment

AU - Kort, P.M.

AU - Murto, P.

AU - Pawlina, G.

PY - 2010

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N2 - We analyze the optimal investment strategy of a firm that can complete a project either in one stage at a single freely chosen time point or in incremental steps at distinct time points. The presence of economies of scale gives rise to the following trade-off: lumpy investment has a lower total cost, but stepwise investment gives more flexibility by letting the firm choose the timing individually for each stage. Our main question is how uncertainty in market development affects this trade-off. The answer is unambiguous and in contrast with a conventional real-options intuition: higher uncertainty makes the single-stage investment more attractive relative to the more flexible stepwise investment strategy.

AB - We analyze the optimal investment strategy of a firm that can complete a project either in one stage at a single freely chosen time point or in incremental steps at distinct time points. The presence of economies of scale gives rise to the following trade-off: lumpy investment has a lower total cost, but stepwise investment gives more flexibility by letting the firm choose the timing individually for each stage. Our main question is how uncertainty in market development affects this trade-off. The answer is unambiguous and in contrast with a conventional real-options intuition: higher uncertainty makes the single-stage investment more attractive relative to the more flexible stepwise investment strategy.

M3 - Article

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EP - 203

JO - European Journal of Operational Research

JF - European Journal of Operational Research

SN - 0377-2217

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