Options, the Value of Capital, and Investment

43 Pages Posted: 19 Jul 2000 Last revised: 15 Oct 2022

See all articles by Andrew B. Abel

Andrew B. Abel

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Avinash Dixit

Princeton University - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Janice C. Eberly

Northwestern University - Kellogg School of Management

Robert S. Pindyck

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: August 1995

Abstract

Capital investment decisions must recognize the limitations on the firm's ability later to sell off or expand capacity. This paper shows how opportunities for future expansion or contraction can be valued as options, how this valuation relates to the q-theory of investment, and how these options affect the incentive to invest. Generally, the option to expand reduces the incentive to invest, while the option to disinvest raises it. We show how these options interact to determine the effect of uncertainty on investment, how these option values change in response to shifts of the distribution of future profitability, and how the q-theory and option pricing approaches to investment are related.

Suggested Citation

Abel, Andrew B. and Dixit, Avinash K. and Eberly, Janice C. and Pindyck, Robert S., Options, the Value of Capital, and Investment (August 1995). NBER Working Paper No. w5227, Available at SSRN: https://ssrn.com/abstract=225291

Andrew B. Abel (Contact Author)

University of Pennsylvania - Finance Department ( email )

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Avinash K. Dixit

Princeton University - Department of Economics ( email )

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Janice C. Eberly

Northwestern University - Kellogg School of Management ( email )

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Robert S. Pindyck

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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