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Stepwise investment and capacity sizing under uncertainty

Author

Listed:
  • Michail Chronopoulos

    (University of Brighton
    Norwegian School of Economics)

  • Verena Hagspiel

    (Norwegian University of Science and Technology)

  • Stein-Erik Fleten

    (Norwegian University of Science and Technology)

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 and the investment premium associated with stepwise investment is positive, 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.

Suggested Citation

  • Michail Chronopoulos & Verena Hagspiel & Stein-Erik Fleten, 2017. "Stepwise investment and capacity sizing under uncertainty," OR Spectrum: Quantitative Approaches in Management, Springer;Gesellschaft für Operations Research e.V., vol. 39(2), pages 447-472, March.
    • Handle: RePEc:spr:orspec:v:39:y:2017:i:2:d:10.1007_s00291-016-0460-0
    DOI: 10.1007/s00291-016-0460-0
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    7. Zixuan Zhang & Michail Chronopoulos & Dimitrina S. Dimitrova & Ioannis Kyriakou, 2024. "Risk assessment and optimal scheduling of serial projects," OR Spectrum: Quantitative Approaches in Management, Springer;Gesellschaft für Operations Research e.V., vol. 46(3), pages 709-736, September.
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    More about this item

    Keywords

    Investment analysis; Capacity sizing; Flexibility; Real options;
    All these keywords.

    JEL classification:

    • G00 - Financial Economics - - General - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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