The interaction of flexible versus dedicated technology choice with financial risk management under financial constraints
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This paper analyzes the impact of financial constraints in a capacity investment setting. We model a monopolist firm that decides on its technology choice (flexible versus dedicated) and capacity level under demand uncertainty. Differing from the majority of the stochastic capacity investment literature, we assume that the firm is budget-constrained both in the capacity investment and production stages, and that the production stage budget is stochastic. Our analysis contributes to the capacity investment literature by extending the theory of stochastic capacity investment to understand the impact of financial constraints, and by analyzing the impact of budget variability on the profitability of the firm. We demonstrate that budget variability is detrimental for the firm with either technology, thus the firm is better off by hedging the budget uncertainty through proper risk management. One of our main contributions is to analyze the impact of financial constraints on the flexible versus dedicated technology choice. We demonstrate that without production costs,a higher internal budget favors the flexible technology only when the fixed cost of the flexible technology is higher. With production costs in place, and in the absence of fixed cost difference, a higher internal budget favors the dedicated technology. This is because the total investment cost is higher with the dedicated technology.