Real Investment, Capital Intensity and Interest Rates

16 Pages Posted: 21 Oct 1996

See all articles by Dennis R. Capozza

Dennis R. Capozza

Ross School of Business, University of Michigan

Yuming Li

California State University

Date Written: May 2, 1996

Abstract

In a growing economy the cash flows from investment projects can be expected to be rising over time. In this paper we explore the interactions of growth and uncertainty of cash flows with variable capital intensity in the decision to invest. We derive simple replacements for the usual neoclassical optimal investment rules based on IRR or NPV. We show that the ability to vary capital intensity raises the specter of perverse responses of investment to interest rates. Variable capital intensity is a sufficient condition for the perverse responses that can occur when growth rates are high or uncertainty is high. An empirical analysis of a panel data set on residential investment in the 1980sconfirms the predictions of the model and finds that about 40% of the observations fall in the positive response region.

JEL Classification: D81, E22, G31

Suggested Citation

Capozza, Dennis R. and Li, Yuming, Real Investment, Capital Intensity and Interest Rates (May 2, 1996). Available at SSRN: https://ssrn.com/abstract=3447 or http://dx.doi.org/10.2139/ssrn.3447

Dennis R. Capozza (Contact Author)

Ross School of Business, University of Michigan ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734 995 7271 (Phone)
734 629-0635 (Fax)

Yuming Li

California State University ( email )

School of Business Box 6848
Fullerton, CA 92834-9480
United States
714-278-2217 (Phone)
714-278-2161 (Fax)

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