We analyze the optimal investment strategy of a firm that can complete a project either in one stage at a single freely chosen time point or in incremental steps at distinct time points. The presence of economies of scale gives rise to the following trade-off: lumpy investment has a lower total cost, but stepwise investment gives more flexibility by letting the firm choose the timing individually for each stage. Our main question is how uncertainty in market development affects this tradeoff. The answer is unambiguous and in contrast with a conventional real-options intuition: higher uncertainty makes the single-stage investment more attractive relative to the more flexible stepwise investment strategy.
REF compare a single-stage investment to a flexible stepwise investment strategy and show that higher price uncertainty makes the former strategy more attractive relative to the latter by raising the reluctance to make costly switches between states.
Uncertainty and stepwise investment
European Journal of Operational Research
Economics Computer Science