The Manufacturing Flexibility to Switch Products: Valuation and Optimal Strategy
AbstractThis paper applies a dynamic programming methodology to the valuation problem for the flexibility to switch. In our model, flexibility provides an investor with the right, or option, to perform a switch between a less profitable and a more profitable project at no cost. In contrast to previous analyses, the option to switch can be exercised in the future at any time during the decision horizon. We present the solution methodology that allows to determine the value of the flexibility and to identify the optimal timing of the switching decision. Comparative statics demonstrate how changes in the input parameters affect the values of the problem"s solution. The results partially explain why investing in flexible manufacturing systems is reported to have both low profitability and rate of diffusion.
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Bibliographic InfoPaper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 292.
Date of creation: 11 Aug 2004
Date of revision:
manufacturing flexibility; real option; capital budgeting;
Find related papers by JEL classification:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-08-16 (All new papers)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Triantis, Alexander J & Hodder, James E, 1990. " Valuing Flexibility as a Complex Option," Journal of Finance, American Finance Association, vol. 45(2), pages 549-65, June.
- McDonald, Robert L & Siegel, Daniel R, 1985. "Investment and the Valuation of Firms When There Is an Option to Shut Down," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(2), pages 331-49, June.
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