Abstract
Capacity management of a plant in capital-intensive industries is a challenging task: volatile markets, aging and deteriorating equipment and a competitive environment raise challenges for capacity management. Essentially, capacity management is decision-making under uncertainty at the plant-level. Risk-informed, dynamic, capacity management is a prerequisite for achieving optimal capacity in a production plant. One way to deal with uncertainty is the active management of real options. Investment portfolios consisting of real options provide opportunistic value in capacity investment decision-making. A framework for the specification, evaluation and exercising of real options is presented for capacity managers. The analysis is based on a decision cycle which is temporally divided into two market outlook periods. The first market outlook period represents the current, emerging market situation for which real options, planned in the previous decision cycle, may be exercised, thus optimising production capacity according to current demand. The second period represents an uncertain production environment for which real options can be planned, based on demand & supply forecasts. The decision cycles repeat, each entailing planning, evaluation and exercising of real options included in the investment portfolio. The framework supports the computation of the probability distribution of profits coupled with alternative investment portfolios. The paper introduces a straightforward way of adopting options theory in the context of real options in capacity management.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
References
Archer, N.P. & Ghasemzadeh (1999) F. An integrated framework for project portfolio selection. International Journal of Project Management 17 (4), 207–216.
Bengtsson, J. (2001) Manufacturing Flexibility and real options: A review. International Journal of Production Economics 74, 213–224.
Fabrycky, W.J. & Blanchard, B.S. (1991) Life-Cycle Cost and Economic Analysis. Englewood Cliffs, NJ: Prentice Hall.
Fontes, D. (2008) Fixed versus flexible production systems: A real options analysis. European Journal of Operational Research 188, 169–184.
Hallgren, M. & Olhager, J. (2009) Flexibility configurations: Empirical analysis of volume and product mix flexibility. Omega, International Journal of Management Science 37, 746–756.
Keswani, A. & Shackleton (2006) M.B. How real option disinvestment flexibility augments project NPV. European Journal of Operational Research 168, 240–252.
Komonen, K., Kortelainen, H. & Räikkönen, M. (2006) An asset management framework to improve longer term returns on investments in the capital intensive industries. In: Proc 1st World Cong on Eng Asset Mgt (WCEAM). Queensland, Australia.
Kulatilaka, N. (1988) Valuing the flexibility of flexible manufacturing systems. IEEE Transactions on Engineering Management 35 (4), 250–257.
Kumar, R. Understanding DSS value: an options perspective. Omega, International Journal of Management Science 27, 295–304, 1999.
Martikainen, J. (2002) Portfolio Management of Strategic Investments in Metal Products Industry. Master’s Thesis. Helsinki University of Technology. Department of Engineering Physics and Mathematics. Helsinki.
Miller, L.T. & Park, C.S. (2002) Decision making under uncertainty – real options to the rescue? Engineering Economist 47(2), 105–150.
Ramezani, C.A. (2003) Real options, corporate performance, and shareholder value creation. In: 7th Annual Int’l Conf on Real Options: Theory meets Practice. Washington, DC.
Rosqvist, T., Räikkönen, M. & Komonen, K. (2007) Investment Analysis for capacity management based on real options. In: 2nd World Congress on Engineering Asset Management, 4th International Conference on Condition Monitoring. Harrogate, UK, 11–14 June 2007. Coxmoor Publishing Company. Northampton, UK.
Sethi, A.K. & Sethi, S.P. (1990) Flexibility in manufacturing: A survey. International Journal of Flexible Manufacturing Systems 2, 289–328.
Trigeorgis, L. (1996) Real Options – Managerial Flexibility and strategy in resource allocation. London: The MIT Press.
Yeo, K.T. & Qiu, F. (2003) The value of management flexibility – a real option approach to investment evaluation. International Journal of Project Management 21 (4), 243–250.
Author information
Authors and Affiliations
Editor information
Editors and Affiliations
Rights and permissions
Copyright information
© 2010 Springer
About this chapter
Cite this chapter
Rosqvist, T. (2010). Capacity Investment Planning Based on Real Options. In: Amadi-Echendu, J., Brown, K., Willett, R., Mathew, J. (eds) Definitions, Concepts and Scope of Engineering Asset Management. Engineering Asset Management Review, vol 1. Springer, London. https://doi.org/10.1007/978-1-84996-178-3_8
Download citation
DOI: https://doi.org/10.1007/978-1-84996-178-3_8
Publisher Name: Springer, London
Print ISBN: 978-1-84996-177-6
Online ISBN: 978-1-84996-178-3
eBook Packages: EngineeringEngineering (R0)