A financial model of flexible manufacturing systems planning under uncertainty: Identification, valuation and applications of real options

A financial model of flexible manufacturing systems planning under uncertainty: Identification, valuation and applications of real options

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Article ID: iaor20082362
Country: United Kingdom
Volume: 45
Issue: 6
Start Page Number: 1389
End Page Number: 1404
Publication Date: Jan 2007
Journal: International Journal of Production Research
Authors: , ,
Abstract:

Flexible manufacturing systems (FMS) have been considered to be essential for manufacturers to succeed in the uncertain market place. Flexibility typically comes at a price and is only valuable as a hedge against environmental uncertainty. It is important to determine an appropriate level of flexibility in the production system while considering the tradeoffs between its costs and benefits. This paper proposes to apply a real option theoretic approach to the modeling and analysis of various types of uncertainty involved in an FMS’s operational environment. In comparison with financial options, real options in the context of an FMS, namely, production options, are identified and accordingly a pricing model for production options is proposed based on the option theory. Based on the valuation of production options, a general framework of flexibility planning is formulated. The real option approach surmounts traditional discounted cash flow analysis based valuation methods that tend to ignore the upside potentials to an investment from management flexibility. The proposed model is tested in a refrigerator company that deals with high product variety and uncertain demand.

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