Dynamic capacity investment and debt financing

Abstract

It is common for companies to conduct multiple capacity expansions in a growing market. In this article, we study how firms make optimal multi-stage investment timing, scale, and capital structure decisions in the context of multiple growth options and existing assets. We show that with multiple growth options, a levered firm accelerates the timing and reduces the scale of investment at each stage relative to an unlevered firm. We also show that as the number of growth options increases, future growth options can reduce the initial investment scale and accelerate the initial investment timing. The effect of scale reduction at the initial investment stage is more pronounced for levered firms relative to unlevered firms. Furthermore, for firms with no fewer than three investment options, the optimal leverage ratio in each stage first decreases and then increases as the investment options are exercised, the U-shape in borrowing shows the balance between early caution and late-stage boldness in multi-stage financing.