Investments of Uncertain Cost

29 Pages Posted: 8 Jun 2004  

Robert S. Pindyck

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

Date Written: September 1992

Abstract

I study irreversible investment decisions when projects take time to complete, and are subject to two types of uncertainty over the cost of completion. The first is technical uncertainty, i.e., uncertainty over the amount of time, effort, and materials that will ultimately be required to complete the project, and that is only resolved as the investment proceeds. The second is input cost uncertainty, i.e., uncertainty over the prices and quantities of labor and materials required, and which is external to the firm's investment activity. I derive a simple decision rule that maximizes the firm's value, and I use it to show how these two types of uncertainty have very different effects on investment decisions. As an example. I analyze the decision to start or continue building a nuclear power plant during the 1980's.

Suggested Citation

Pindyck, Robert S., Investments of Uncertain Cost (September 1992). NBER Working Paper No. w4175. Available at SSRN: https://ssrn.com/abstract=257826

Robert S. Pindyck (Contact Author)

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

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HOME PAGE: http://web.mit.edu/rpindyck/www/

National Bureau of Economic Research (NBER)

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