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Options, the Value of Capital, and InvestmentAndrew B. AbelUniversity of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER) Avinash DixitPrinceton University - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute for Economic Research) Janice C. EberlyNorthwestern University - Kellogg School of Management Robert S. PindyckMassachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER) November 1996 NBER Working Paper No. w5227 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.
Number of Pages in PDF File: 43 working papers seriesDate posted: July 19, 2000Suggested CitationContact Information
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