Volume Flexibility and Capacity Investment: A Real Options Approach

CentER Discussion Paper Series No. 2015-022

30 Pages Posted: 2 Apr 2015

See all articles by Xingang Wen

Xingang Wen

Tilburg University - Center for Economic Research (CentER)

Peter M. Kort

Tilburg University - Department of Econometrics & Operations Research; Tilburg University - Center for Economic Research (CentER)

Dolf Talman

Tilburg University - Department of Econometrics & Operations Research

Date Written: April 1, 2015

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.

Keywords: Investment under Uncertainty, Monopoly, Capacity Choice

JEL Classification: D81, D92

Suggested Citation

Wen, Xingang and Kort, Peter and Talman, Dolf J. J., Volume Flexibility and Capacity Investment: A Real Options Approach (April 1, 2015). CentER Discussion Paper Series No. 2015-022, Available at SSRN: https://ssrn.com/abstract=2588444 or http://dx.doi.org/10.2139/ssrn.2588444

Xingang Wen (Contact Author)

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Peter Kort

Tilburg University - Department of Econometrics & Operations Research ( email )

Tilburg, 5000 LE
Netherlands
+31 13 466 2062 (Phone)
+31 13 466 3072 (Fax)

HOME PAGE: http://center.uvt.nl/staff/kort/

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2062 (Phone)
+31 13 466 3072 (Fax)

Dolf J. J. Talman

Tilburg University - Department of Econometrics & Operations Research ( email )

Tilburg, 5000 LE
Netherlands
+31 13 466 2346 (Phone)

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