Information Arrival and Real Investment
نویسنده
چکیده
Information Arrival and Real Investment We analyze the investment decision of the rm under uncertainty. The objective of the paper is to create a generic framework to investigate the respective roles of irreversible or sunk costs of investment and the nature of the resolution of uncertainty in determining the behavior of the hurdle rate. We show analytically that the mode of information arrival is the sole factor that determines the behavior of the option-adjusted hurdle rate. Thus, if the resolution of uncertainty is exogenous to the rm, the option-adjusted hurdle rate is greater than the traditional hurdle rate and increases with the level of uncertainty. In contrast, if the resolution of uncertainty is endogenous, the option-adjusted hurdle rate is lower than the traditional and decreases with the level of uncertainty. The existence of sunk costs, no matter how high, is not su cient to cause the hurdle rate to be greater than traditional. Further, we show that embedded options have value even in the absence of sunk costs. The framework also allows a straightforward comparison between the traditional analysis and the option-adjusted analysis under uncertainty and the conditions under which the myopic traditional approach is true.
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