The effect of financing decisions on the choice of manufacturing technologies

Abstract

Abstract. This paper demonstrates the importance of jointly considering financing and technology choices when making manufacturing investments. We show that considerable value can be added to investments through financing decisions, and that the gains due to financing are sensitive to technology choice. A model of financing and technology choice is presented that considers differences in cost structure and product flexibility, and applies it to an example involving flexible manufacturing systems (FMSs). Three main results emerge. First, optimal financing decisions are different for different technologies and the choice of technology can change when financing and technology decisions are made simultaneously. Second, if one technology's fixed and variable costs are lower or its initial investment higher than another technology's the former has higher value added due to financing. Since empirical data shows that FMS and conventional technologies have this pattern, ignoring the benefits of debt financing leads to undervaluation of new technology. Third, product flexibility can add considerable value through its effect on financing decisions because product flexibility reduces variability of cash flows. A major conclusion is that financing and technology choice are long-term strategic decisions that should be made jointly. Firms that make these decisions separately, not considering the effect of one on the other, may make suboptimal technology decisions.

Stochastic Capacity Investment and Flexible Versus Dedicated Technology Choice in Imperfect Capital Markets

“…Except for a numerical analysis in Lederer and Singhal (1994), there is no formal treatment of the two-product firm in the literature, therefore, the two-product analysis is a distinct contribution of our research.…”

“…An analytical characterization of the two-product firm is entirely new to this literature. The only paper to focus on flexible technology is Lederer and Singhal (1994), whose main focus is to study the joint financing (optimal mix of debt and equity) and capacity investment problem in a single-product, multi-period setting under the assumption of a perfectly competitive credit market. In a numerical example, they analyze the capacity-pooling benefit of flexible technology in a multi-product firm.…”

Vertical Flexibility, Outsourcing and the Financial Choices of the Firm

“…Contributions on the link between industrial decisions and financial structure may be found in Lederer and Singhal (1994), in Leland (1998) Leland (1998) digs the same topic raised in the seminal paper of Jensen and Meckling (1976). Unlike Leland (1998), Mauer and Sarkar (2005) emphasize the inefficiency of debt.…”

“…However, investing in a flexible technology with a high c t is too risky and the equityholders choose zero flexibility. 26 The comparison with respect to the unlevered firm is summarized in the following proposition: 2 6 This is consistend with the comparative statics of (26.2) and (26.3). That is, …”

“…In our endeavor we shall couple two streams of contributions: one on vertical flexibility and the timing of adoption of a specific technology to carry out OS (Moretto and Rossini, 2012; Shy and Stenbacka, 2005; Alvarez and Stenbacka, 2007; Alipranti, Miliou and Petrakis, 2014) and another on financial choices of a firm in an uncertain dynamic framework (Leland, 1994;Lederer and Singhal, 1994;Banerjee et al, 2014;Triantis and Hodder, 1990).…”