Stepwise Investment and Capacity Sizing Under Uncertainty
30 Pages Posted: 15 Feb 2015
Date Written: February 13, 2015
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: Suggested Citation