A real options approach to a classical capacity expansion problem

Some authors, considering deterministic or stochastic demand patterns and different forecasting formulations, have studied the classical problem of optimally meeting a growing demand for capacity, over an infinite horizon. With this approach, only investment costs discounted with a predefined interest rate are considered in the analysis. In this paper we first review the classical capacity expansion models. Then, the concepts and properties of the real options approach, with emphasis on the Black–Scholes equation, are briefly discussed. Finally, an application example is presented and discussed.