Rights statement: The original publication is available at www.springerlink.com
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Research output: Contribution to Journal/Magazine › Journal article › peer-review
Research output: Contribution to Journal/Magazine › Journal article › peer-review
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TY - JOUR
T1 - Strategic capital budgeting: asset replacement under market uncertainty
AU - Pawlina, G
AU - Kort, Peter M
N1 - The original publication is available at www.springerlink.com
PY - 2003/10
Y1 - 2003/10
N2 - 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.
AB - 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.
KW - Capital budgeting
KW - Real options
KW - First passage time
KW - Product market uncertainty
KW - Cournot duopoly
U2 - 10.1007/s00291-003-0137-3
DO - 10.1007/s00291-003-0137-3
M3 - Journal article
VL - 25
SP - 443
EP - 479
JO - OR Spectrum
JF - OR Spectrum
SN - 0171-6468
IS - 4
ER -