Expandability, Reversibility, and Optimal Capacity Choice
Princeton University - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)
Robert S. Pindyck
Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)
NBER Working Paper No. w6373
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.
Number of Pages in PDF File: 31
Date posted: July 14, 2000