OPTIMAL CAPACITY IN THE ANHYDROUS AMMONIA INDUSTRY

This study analyzed the status of manufacturing capacity in the U.S. a nhydrous ammonia industry (1971-91). Pindyck's (1988) real option mode l was extended to account for mean-reverting tendencies in the marketi ng margin to determine optimal capacity for each year. The key result of the study is that the 30% expansion in 1973-74 would not have been recommended by the real option model, while traditional discounted cas h how approaches available in the 1970s could have easily rationalized the choices made by the industry. The results underscore the potentia l gains in predictive power from using the real option model in analyz ing large, irreversible investments.