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Department of Business and Management Science, Norwegian School of Economics (NHH) Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)

No 2015/10:
Stepwise Investment and Capacity Sizing under Uncertainty

Michail Chronopoulos (), Verena Hagspiel () and Stein–Erik Fleten ()

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; (follow links to similar papers)

JEL-Codes: G00; G10; G11; (follow links to similar papers)

29 pages, February 13, 2015

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