Title
Volume flexibility and capacity investment under demand uncertainty Volume flexibility and capacity investment under demand uncertainty
Author
Faculty/Department
Faculty of Applied Economics
Publication type
article
Publication
Amsterdam ,
Subject
Economics
Mathematics
Source (journal)
International journal of production economics. - Amsterdam
Volume/pages
178(2016) , p. 95-108
ISSN
0925-5273
ISI
000379562500010
Carrier
E
Target language
English (eng)
Full text (Publishers DOI)
Affiliation
University of Antwerp
Abstract
The paper considers optimal capacity investment decisions under uncertainty taking a real options approach. Concerning the production decision, we study a flexible and an inflexible scenario. The flexible firm can costlessly adjust, production over time with the capacity level as the upper bound, while the inflexible firm fixes production at capacity level from the moment of investment onwards. We find that the flexible firm invests in higher capacity than the inflexible firm, where the capacity difference increases with uncertainty. For the flexible firm the initial capacity utilization rate can be quite low, especially when investment costs are concave and the economic environment is uncertain. As to the timing of the investment there are two contrary effects. First, the flexible firm has an incentive to invest earlier, because flexibility raises the project value. Second, the flexible firm has an incentive to invest later, because costs are larger due to the higher capacity level. The latter effect dominates in highly uncertain economic environments. Our model being dynamic enables us to derive the at first sight counterintuitive result that an increase in capacity holding cost raises the capacity level the firm invests in. (C) 2016 Elsevier B.V. All rights reserved.
E-info
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https://repository.uantwerpen.be/docman/iruaauth/072814/134940.pdf
Handle