Expandability, Reversibility, and Optimal Capacity Choice
31 Pages Posted: 14 Jul 2000 Last revised: 6 Jun 2002
Date Written: January 1998
We develop continuous-time models of capacity choice when demand fluctuates stochastically, and the firm's opportunities to expand or contract are limited. Specifically consider costs of investing or disinvesting that vary with time, or with the amount of capacity already installed. The firm's limited opportunities to expand or contract create call and put options on incremental units of capital; we show how the values of these options affect the firm's investment decisions.
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