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The Manufacturing Flexibility to Switch Products: Valuation and Optimal Strategy

  • Sorin Tuluca
  • Piotr Stalinski

This 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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File URL: http://repec.org/sce2004/up.32174.1078030138.pdf
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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2004 with number 292.

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Date of creation: 11 Aug 2004
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Handle: RePEc:sce:scecf4:292
Contact details of provider: Web page: http://comp-econ.org/
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  1. 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.
  2. 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.
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