Stepwise Investment and Capacity Sizing Under Uncertainty

30 Pages Posted: 15 Feb 2015

See all articles by Michail Chronopoulos

Michail Chronopoulos

City University London - Sir John Cass Business School; Norwegian School of Economics (NHH) - Department of Business and Management Science

Verena Hagspiel

Norwegian University of Science and Technology (NTNU) - Department of Industrial Economics and Technology

Stein-Erik Fleten

Norwegian University of Science and Technology (NTNU)

Date Written: February 13, 2015

Abstract

The relationship between uncertainty and managerial flexibility is particularly crucial in addressing capital projects. We consider a firm that can invest in a project in either a single (lumpy investment) or multiple stages (stepwise investment) under price uncertainty and has discretion over not only the time of investment but also the size of the project. We confirm that, if the capacity of a project is fixed, then lumpy investment becomes more valuable than a stepwise investment strategy under high price uncertainty. By contrast, if a firm has discretion over capacity, then we show that the stepwise investment strategy always dominates that of lumpy investment. In addition, we show that the total amount of installed capacity under a stepwise investment strategy is always greater than that under lumpy investment.

Keywords: Investment analysis, capacity sizing, flexibility, real options

JEL Classification: G00, G10, G11

Suggested Citation

Chronopoulos, Michail and Chronopoulos, Michail and Hagspiel, Verena and Fleten, Stein-Erik, Stepwise Investment and Capacity Sizing Under Uncertainty (February 13, 2015). NHH Dept. of Business and Management Science Discussion Paper No. 2015/10, Available at SSRN: https://ssrn.com/abstract=2564597 or http://dx.doi.org/10.2139/ssrn.2564597

Michail Chronopoulos (Contact Author)

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

HOME PAGE: http://https://www.cass.city.ac.uk/

Norwegian School of Economics (NHH) - Department of Business and Management Science ( email )

Helleveien 30
Bergen, NO-5045
Norway

Verena Hagspiel

Norwegian University of Science and Technology (NTNU) - Department of Industrial Economics and Technology ( email )

NO-7491 Trondheim
Norway

Stein-Erik Fleten

Norwegian University of Science and Technology (NTNU) ( email )

NO-7491 Trondheim
Norway

HOME PAGE: http://www.iot.ntnu.no/users/fleten

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