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Investment and Abandonment Decisions with Uncertain Price and Cost

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  • Yoon K. Choi
  • Seok Weon Lee

Abstract

We analyze firms’ investment and abandonment decisions when both output price and investment cost change stochastically. The model allows for and makes endogenous the abandonment decision, thereby incorporating irreversibility. We show that the investment trigger may be much higher than the standard net present value rule suggests even when a substantial portion of the investment cost may be recovered. Further, we argue that the correlation between output price and investment costs significantly affects the effect of irreversibility on investment behavior. Empirical implications are discussed with extensive numerical illustrations, along with an application to the banking industry.

Suggested Citation

  • Yoon K. Choi & Seok Weon Lee, 2000. "Investment and Abandonment Decisions with Uncertain Price and Cost," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 27(1‐2), pages 195-213, January.
    • Handle: RePEc:bla:jbfnac:v:27:y:2000:i:1-2:p:195-213
    DOI: 10.1111/1468-5957.00310
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    Cited by:

    1. Zhuming Chen & Sijia Zhang & Tao Lin, 2020. "Optimal Timing And Terms In A Vertical Merger With Two Sources Of Uncertainty," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 43(2), pages 345-372, May.
    2. Monica Neamtiu & Nemit Shroff & Hal D. White & Christopher D. Williams, 2014. "The Impact of Ambiguity on Managerial Investment and Cash Holdings," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 41(7-8), pages 1071-1099, September.
    3. Won, Chaehwan, 2009. "Valuation of investments in natural resources using contingent-claim framework with application to bituminous coal developments in Korea," Energy, Elsevier, vol. 34(9), pages 1215-1224.

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