In this paper, we develop a bi-level real options framework for deriving the equilibrium Government subsidisation and firm-level capacity investment policy in a duopoly market structure. We find that strategic interactions with the Government may impact a firm’s capacity investment decision significantly and that the equilibrium subsidisation policy depends on both the market structure and the type of duopolistic competition. Interestingly, the provision of greater subsidy to the leader raises the follower’s incentive to invest earlier and in a bigger project. The loss in value of the leader, due to the follower’s entry, relative to the monopolist increases with economic uncertainty and, although a subsidy can mitigate this loss, its effect becomes less pronounced as economic uncertainty increases. We also find that a profit (welfare)-maximising Government does not offer (offers) a subsidy in a highly uncertain environment or upon low tax rate, while higher tax rate does not always decelerate investment. Finally, we find that while competition is always desirable for a social planner, a profit-maximising Government may benefit more under pre-emptive competition. •We analyse equilibrium investment and subsidy design under duopolistic competition.•The subsidisation policy depends on both market structure and type of competition.•Increasing the leader’s subsidy hastens the follower’s investment in a bigger project.•The subsidy mitigates the leader’s loss in value due to the follower’s entry.•A profit-maximising Government does not offer a subsidy under high uncertainty.