Production and Capacity Management with Internal Financing

39 Pages Posted: 6 Feb 2016 Last revised: 11 Oct 2017

See all articles by Jie Ning

Jie Ning

Case Western Reserve University - Weatherhead School of Management

Matthew J. Sobel

Case Western Reserve University; Weatherhead School of Management, Case Western Reserve University

Date Written: April 26, 2017

Abstract

We formulate and analyze a stylized dynamic model of a price-taking firm that manages production and capacity, uses only internal financing, and faces stochastic market environments. The firm has two operationally independent production facilities, each of which makes two products, and a cash reserve which finances all operations and dividend issuance. Each period the firm chooses the amount of dividend to issue and at each facility it chooses production quantities and amounts of capacity to augment or divest. Relevant market data are exogenous and evolve stochastically. We completely characterize the optimal policy and the endogenous values of the capacities and cash reserve, and show that they invite a real-option interpretation. We find that internal financing creates a spillover between the endogenous values of the two operationally independent facilities and we specify how this leads to interdependence of their optimal policies. We show that an “invest/stay put/divest” (ISD) policy remains optimal for partially irreversible investments, but internal financing changes the ISD thresholds. If the exogenous data are intertemporally independent, an internally financed firm is less likely to issue dividends or to expand capacity than if it were in a perfect capital market. As the market becomes more volatile, the endogenous values of capacities and cash increase, and the firm becomes more reluctant to issue dividends.

Keywords: Capacity planning and investment, OM-Finance interface, real option, dynamic programming

JEL Classification: D24, D81, D92, C61

Suggested Citation

Ning, Jie and Sobel, Matthew J., Production and Capacity Management with Internal Financing (April 26, 2017). Available at SSRN: https://ssrn.com/abstract=2727940 or http://dx.doi.org/10.2139/ssrn.2727940

Jie Ning (Contact Author)

Case Western Reserve University - Weatherhead School of Management ( email )

Department of Operations
11119 Bellflower Rd
Cleveland, OH 44106
United States

Matthew J. Sobel

Case Western Reserve University ( email )

10900 Euclid Ave.
Cleveland, OH 44106
United States

HOME PAGE: http://https://weatherhead.case.edu/faculty/emeriti-faculty/matthew-sobel

Weatherhead School of Management, Case Western Reserve University ( email )

10900 Euclid Ave.
Cleveland, OH 44106-7235
United States

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