A model of entry-exit decisions and capacity choice under demand uncertainty

Murat Isik, Keith H. Coble, Darren Hudson, Lisa O. House

Research output: Contribution to journalArticlepeer-review

18 Scopus citations

Abstract

Many investment decisions of agribusiness firms, such as when to invest in an emerging market or whether to expand the capacity of the firm, involve irreversible investment and uncertainty about demand, cost or competition. This paper uses an option-value model to examine the factors affecting an agribusiness firm's decision whether and how much to invest in an emerging market under demand uncertainty. Demand uncertainty and irreversibility of investment make investment less desirable than the net present value (NPV) rule indicates. The inactive firm is more reluctant to enter the market when it takes into account demand uncertainty because it preserves the opportunity of making a better investment later. The active firm is more reluctant to abandon the investment because there is an option value of keeping the operation alive. There is a greater distance between the entry and exit thresholds under the option-value approach than under the NPV rule due to demand uncertainty. The results have implications for agribusiness decision-making.

Original languageEnglish
Pages (from-to)215-224
Number of pages10
JournalAgricultural Economics
Volume28
Issue number3
DOIs
StatePublished - May 2003

Keywords

  • Agribusiness decision-making
  • Demand uncertainty
  • Entry-exit decisions
  • Real options
  • Remote sensing

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