Valuation of Irreversible Entry Options Under Uncertainty and Taxation

Center for Economic Studies WP No. 144

Posted: 11 Feb 1998

See all articles by Vesa Kanniainen

Vesa Kanniainen

University of Helsinki - Department of Political and Economic Studies; CESifo (Center for Economic Studies and Ifo Institute)

Luis Hernan Radomiro Alvarez

University of Turku - Turku School of Economics

Date Written: October 1997

Abstract

We analyze the tax effects on a potential firm with an irreversible entry option and subject to risky post-entry earnings. We formulate the problem in terms of optimal stopping and derive both the necessary conditions for optimal entry and the value of the optimal premium by relying on the classical theory of diffusions and the Green representation of the stochastic value functional. We show that to make the entry option invariant with respect to the tax policy when the government owns a call option on a fraction of firm's earnings, the tax allowance has to satisfy a first-order non-linear differential equation. We derive qualitative results for the neutrality of the tax policy. Using standard geometric Brownian motion to model price uncertainty, we provide examples of the requirements for tax invariance. The Johansson-Samuelson theorem is re-examined.

JEL Classification: D21, D84, G33, C61

Suggested Citation

Kanniainen, Vesa and Radomiro Alvarez E., Luis Hernan, Valuation of Irreversible Entry Options Under Uncertainty and Taxation (October 1997). Center for Economic Studies WP No. 144, Available at SSRN: https://ssrn.com/abstract=58664

Vesa Kanniainen

University of Helsinki - Department of Political and Economic Studies ( email )

P.O. Box 54
FIN-00014 Helsinki
Finland
+358-0-9-1911 (Phone)
+358-0-191-8877 (Fax)

HOME PAGE: http://www.cesifo.de

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Luis Hernan Radomiro Alvarez E. (Contact Author)

University of Turku - Turku School of Economics ( email )

Rehtorinpellonkat 3
FIN-20500 Turku
Finland

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