The effects of external financing costs on investment timing and sizing decisions

Michi Nishihara () and Takashi Shibata ()
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Michi Nishihara: Graduate School of Economics, Osaka University

No 12-07, Discussion Papers in Economics and Business from Osaka University, Graduate School of Economics

Abstract: We develop a dynamic model in which a firm exercises an option to expand production on either a small or large scale with cash reserves and costly external funds. We show that the financing costs greatly distort the firm fs financing and investment behavior and result in a policy contingent on the dynamics of the cash flow and reserves. Most notably, we prove that an intermediate level of cash reserves is likely to accelerate investment in the small-scale project by interactions among financing costs, investment timing, and investment sizing. Our results fill the gap between two types of results: (i) empirical findings in a U-shaped relation between the investment volume and internal funds, and (ii) empirical predictions of a U-shaped relation between the investment timing and internal funds.

Keywords: Investment timing; Investment size; Costly external financing; Optimal stopping (search for similar items in EconPapers)
JEL-codes: G13 G31 G32 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2012-04
New Economics Papers: this item is included in nep-dge, nep-fdg, nep-mac and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Journal Article: The effects of external financing costs on investment timing and sizing decisions (2013)
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