Strategic capital budgeting: asset replacement under market uncertainty

In this paper the impact of product market uncertainty on the optimal replacement timing of a production facility is studied. The existing production facility can be replaced by a technologically more advanced and thus more cost-effective one. We take into account strategic interactions among the firms competing in the product market by analyzing the problem in a duopolistic setting. We calculate the value of each firm and show that i) a preemptive (simultaneous) replacement occurs when the associated sunk cost is low (high), ii) despite the preemption effect uncertainty always raises the expected time to replace, and iii) the relationship between the probability of optimal replacement within a given time interval and uncertainty is decreasing for long time intervals and humped for short time intervals. Furthermore it is shown that result ii) carries over to the case where firms have to decide about starting production rather than about replacing existing facilities

Uncertainty and stepwise investment

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 trade-off. 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

Innovation Strategies in a Competitive Dynamic Setting

This paper presents a dynamic model of a competitive R&D and production duopoly subject to knowledge spillovers. Two asymmetric firms operate for a limited period of time and dispose their knowledge capital in the end. Both firms and the social planner prefer the R&D-cooperative strategy over the competitive one regardless of the intensity of knowledge spillovers. Accumulation of knowledge capital results allows the monopolist to have lower marginal cost of production and charge a lower market price than a fully competitive duopoly. Being able to define the degree of knowledge exchange when creating a research joint venture, the firms do not necessary choose the highest degree of cooperation available.innovation, R&D, spillovers, cooperation