Scandinavian Working Papers in Economics
Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science
No 2015/10: Stepwise Investment and Capacity Sizing under Uncertainty
Michail Chronopoulos (), Verena Hagspiel () and Stein–Erik Fleten ()
Additional contact information
Michail Chronopoulos: Dept. of Business and Management Science, Norwegian School of Economics, Postal: NHH , Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway
Verena Hagspiel: Dept. of Industrial Economics and Technology Management, Norwegian University of Science and Technology, Postal: Norwegian University of Science and Technology, Department of Industrial Economics and Technology Management, 7491 Trondheim, Norway
Stein–Erik Fleten: Dept. of Industrial Economics and Technology Management, Norwegian University of Science and Technology, Postal: Norwegian University of Science and Technology, Department of Industrial Economics and Technology Management, 7491 Trondheim, Norway
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
29 pages, February 13, 2015
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