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Stepwise Investment and Capacity Sizing under Uncertainty

Chronopoulos, Michail; Hagspiel, Verena; Fleten, Stein-Erik
Working paper
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URI
http://hdl.handle.net/11250/276263
Date
2015-02-13
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  • Discussion papers (FOR) [556]
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.
Publisher
FOR
Series
Discussion paper;10/15

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