Volume flexibility and capacity investment: a real options approach

Xingang Wen, Peter Kort, Dolf Talman

Research output: Contribution to journalArticleScientificpeer-review

Abstract

This paper considers the investment decision of a firm where it has to decide about the timing and capacity. We obtain that in a fast-growing market, right after investment the firm produces below capacity, where the utilization rate (the proportion of capacity that is used for production right after the investment) increases with market uncertainty for a very big market trend, and shows no monotonicity for a moderately large market trend. On the other hand, we get that, for a slowly growing or shrinking market, the firm produces up to capacity right after investment. In the intermediate case, the firm produces up to capacity right after investment when uncertainty is low and below capacity when uncertainty is high, whereas the utilization rate decreases with the market uncertainty.
LanguageEnglish
Pages1633-1646
Number of pages14
JournalThe Journal of the Operational Research Society
Volume68
Issue number12
DOIs
StatePublished - 1 Dec 2017

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Real options
Volume flexibility
Capacity investment
Uncertainty
Utilization rate
Market uncertainty
Investment decision
Monotonicity
Proportion

Keywords

  • investment under uncertainty
  • volume flexibility
  • capacity choice
  • monopoly

Cite this

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Volume flexibility and capacity investment: a real options approach. / Wen, Xingang; Kort, Peter; Talman, Dolf.

In: The Journal of the Operational Research Society, Vol. 68, No. 12, 01.12.2017, p. 1633-1646.

Research output: Contribution to journalArticleScientificpeer-review

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AB - This paper considers the investment decision of a firm where it has to decide about the timing and capacity. We obtain that in a fast-growing market, right after investment the firm produces below capacity, where the utilization rate (the proportion of capacity that is used for production right after the investment) increases with market uncertainty for a very big market trend, and shows no monotonicity for a moderately large market trend. On the other hand, we get that, for a slowly growing or shrinking market, the firm produces up to capacity right after investment. In the intermediate case, the firm produces up to capacity right after investment when uncertainty is low and below capacity when uncertainty is high, whereas the utilization rate decreases with the market uncertainty.

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