OR Spectrum

, Volume 39, Issue 2, pp 447–472 | Cite as

Stepwise investment and capacity sizing under uncertainty

  • Michail Chronopoulos
  • Verena Hagspiel
  • Stein-Erik Fleten
Regular Article

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.

Keywords

Investment analysis Capacity sizing Flexibility Real options 

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Copyright information

© Springer-Verlag Berlin Heidelberg 2016

Authors and Affiliations

  • Michail Chronopoulos
    • 1
    • 2
  • Verena Hagspiel
    • 3
  • Stein-Erik Fleten
    • 3
  1. 1.School of Computing Engineering and MathematicsUniversity of BrightonBrightonUK
  2. 2.Department of Business and Management ScienceNorwegian School of EconomicsBergenNorway
  3. 3.Department of Industrial Economics and Technology ManagementNorwegian University of Science and TechnologyTrondheimNorway

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