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A Model Of Entry-Exit Decisions And Capacity Choice Under Demand Uncertainty

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Author Info

  • Isik, Murat
  • Coble, Keith H.
  • Hudson, Darren
  • House, Lisa

Abstract

Many investment decisions of agribusiness firms such as when to invest in an emerging market or whether to expand the capacity of the firm involve irreversible investment and uncertainty about demand, cost or competition. This paper uses an option-value model to examine the factors affecting an agribusiness firm's decision whether and how much to invest in an emerging market under demand uncertainty. Demand uncertainty and irreversibility of investment make investment less desirable than the net present value (NPV) rule indicates. The inactive firm is more reluctant to enter the market when it takes into account demand uncertainty because it preserves the opportunity of making a better investment later. The active firm is more reluctant to abandon the investment because there is an option value of keeping the operation alive. There is a greater distance between the entry and exit thresholds under the option-value approach than under the NPV rule due to demand uncertainty. The results have implications for agribusiness decision-making to understand and respond to uncertainty.

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Bibliographic Info

Paper provided by American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association) in its series 2002 Annual meeting, July 28-31, Long Beach, CA with number 19797.

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Date of creation: 2002
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Handle: RePEc:ags:aaea02:19797

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Related research

Keywords: agribusiness decision-making; demand uncertainty; entry-exit decisions; net present value; real options; remote sensing; Demand and Price Analysis;

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References

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  1. Babcock, Bruce A. & Pautsch, Gregory R., 1998. "Moving From Uniform To Variable Fertilizer Rates On Iowa Corn: Effects On Rates And Returns," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 23(02), December.
  2. Pindyck, Robert S., 1986. "Irreversible investment, capacity choice, and the value of the firm," Working papers 1802-86., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  3. Khanna, Madhu & Isik, Murat & Winter-Nelson, Alex, 2000. "Investment in site-specific crop management under uncertainty: implications for nitrogen pollution control and environmental policy," Agricultural Economics, Blackwell, vol. 24(1), pages 9-21, December.
  4. Gary Kachanoski, 1999. "Economic Feasibility of Variable-Rate Technology for Nitrogen on Corn," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 81(4), pages 914-927.
  5. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-57, April.
  6. Isik, Murat & Khanna, Madhu & Winter-Nelson, Alex, 2001. "Sequential Investment In Site-Specific Crop Management Under Output Price Uncertainty," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 26(01), July.
  7. Dixit, A., 1988. "Entry And Exit Decisions Under Uncertainty," Papers 91, Princeton, Department of Economics - Financial Research Center.
  8. Isik, Murat & Khanna, Madhu, 2002. "Variable-Rate Nitrogen Application Under Uncertainty: Implications For Profitability And Nitrogen Use," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 27(01), July.
  9. Murat Isik & Madhu Khanna, 2003. "Stochastic Technology, Risk Preferences, and Adoption of Site-Specific Technologies," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 85(2), pages 305-317.
  10. Majd, Saman & Pindyck, Robert S., 1987. "Time to build, option value, and investment decisions," Journal of Financial Economics, Elsevier, vol. 18(1), pages 7-27, March.
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Cited by:
  1. Seo, Sangtaek & Segarra, Eduardo & Mitchell, Paul D. & Leatham, David J., 2006. "Irrigation Technology Adoption in the Texas High Plains: A Real Options Approach," 2006 Annual meeting, July 23-26, Long Beach, CA 21427, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
  2. Pierre-André Jouvet & Elodie Lecadre & Caroline Orset, 2011. "Irreversible investment, uncertainty, and ambiguity: the case of bioenergy sector," Working Papers 2011/01, INRA, Economie Publique.
  3. Isik, Murat & Yang, Wanhong, 2004. "An Analysis of the Effects of Uncertainty and Irreversibility on Farmer Participation in the Conservation Reserve Program," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 29(02), August.
  4. Lau, Michael H. & Richardson, James W. & Outlaw, Joe L. & Fuller, Stephen W. & Nixon, Clair J. & Herbst, Brian K., 2004. "Location Of A Mixalco Production Facility With Respect To Economic Viability," 2004 Annual meeting, August 1-4, Denver, CO 20025, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
  5. Sameh Hachicha & Leila Kaaniche & Fathi Abid, 2011. "Sequential investment and delay: an agribusiness firm case study," Agricultural Finance Review, Emerald Group Publishing, vol. 71(2), pages 240-258, July.
  6. Engel, Phoebe D. & Hyde, Jeffrey, 2003. "A Real Options Analysis of Automatic Milking Systems," Agricultural and Resource Economics Review, Northeastern Agricultural and Resource Economics Association, vol. 32(2), October.
  7. Feil, Jan-Henning & Musshoff, Oliver, 2012. "Policy Impact Analysis on Investments and Disinvestments under Competition: A Real Options Approach," 2012 Conference (56th), February 7-10, 2012, Freemantle, Australia 124294, Australian Agricultural and Resource Economics Society.

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