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Irreversible Investment, Operating Flexibility, And Time Lags

Author

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  • RYUTA TAKASHIMA

    (Department of Risk Science in Finance and Management, Chiba Institute of Technology, 2-17-1 Tsudanuma, Narashino-shi, Chiba 275-0016, Japan)

  • MAKOTO GOTO

    (Graduate School of Economics and Business Administration, Hokkaido University, Kita 9, Nishi 7, Kita-ku, Sapporo 060-0809, Japan)

  • MOTOH TSUJIMURA

    (Faculty of Economics, Ryukoku University, 67 Tsukamoto-cho, Fukakusa Fushimi-ku, Kyoto 612–8577, Japan)

Abstract

We consider an optimal investment problem when a firm such as an electric power company has the operational flexibility to expand and contract capacity with fixed cost. This problem is formulated as an impulse control problem combined with optimal stopping. Consequently, we obtain optimal investment timing, optimal capacity expansion and contraction timing, and the investment value. We also show investment, capacity expansion and contraction rule are influenced by the price volatility and the initial capacity is also influenced by the ratio between base-load plant and peak-load plant. In addition, we investigate how time lag between investment and operation influences the investment rule.

Suggested Citation

  • Ryuta Takashima & Makoto Goto & Motoh Tsujimura, 2010. "Irreversible Investment, Operating Flexibility, And Time Lags," Asia-Pacific Journal of Operational Research (APJOR), World Scientific Publishing Co. Pte. Ltd., vol. 27(02), pages 271-286.
    • Handle: RePEc:wsi:apjorx:v:27:y:2010:i:02:n:s0217595910002685
    DOI: 10.1142/S0217595910002685
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    References listed on IDEAS

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    1. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    2. Antonio Fuster Olivares & Jose Miguel Giner Perez & Mª Carmen Tolosa Bailen, 2004. "The new economy in Spain: a regional analysis," ERSA conference papers ersa04p284, European Regional Science Association.
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    Cited by:

    1. Boonman, Hettie J. & Siddiqui, Afzal S., 2017. "Capacity optimization under uncertainty: The impact of operational time lags," European Journal of Operational Research, Elsevier, vol. 262(2), pages 660-672.

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