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

Michi Nishihara and Takashi Shibata ()

Journal of Banking & Finance, 2013, vol. 37, issue 4, 1160-1175

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. An intermediate level of cash reserves, which is insufficient for the large-scale investment but sufficient for the small-scale investment, provides an incentive for the firm to invest early in the small-scale project. These results fill the gap between two types of results: (i) empirical findings of 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. In addition, our results have real-world implications for investment in alternative projects.

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)
Date: 2013
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:37:y:2013:i:4:p:1160-1175

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