A capital budgeting model for product-mix flexibility

A financial model is presented for calculating the dollar value of flexible plant capacity under conditions of uncertain market demand. This model assesses the value of the opportunity to respond quickly to shifts in the demand of two different products. Capacity constraints are explicitly considered and the demand correlation between the two products is a parameter in the formulation. The model helps generate insights about key factors that influence the value of flexibility, such as demand uncertainty and demand correlation. An optimal (i.e., net present value maximizing) configuration of flexible vs. dedicated capacity can be determined through iterative use of the model.