Do Growth Options Affect Investment Decision-Making?

Many investments create both fixed assets and options for future investments, or “growth options”. It is natural to expect these future growth options to affect the timing of the initial decision to invest. This paper examines the impact of growth options on this initial decision in a capacity expansion context. We show that the impact of the growth options depends on whether the initial investment opportunity is shortor long-lived. When the investment opportunity has no time limit, the growth options have no effect on the investment decision— optimal behavior is to act as if there were no growth options. On the other hand, when the investment opportunity is finite, consideration of growth options leads to earlier action.