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Optimal timing and capacity choice with taxes and subsidies under uncertainty

Alcino Azevedo, Paulo J. Pereira and Artur Rodrigues ()

Omega, 2021, vol. 102, issue C

Abstract: We develop a real options model that examines the effect of government’s subsidies and taxation policy on the timing and size of investments. We find that a higher depreciation rate or subsidy, or a lower tax rate, accelerates investments. The effect of subsidies on the investment size depends on whether the subsidy is fixed or variable: a fixed subsidy induces smaller size investments, whereas a variable subsidy encourages larger size investments. The tax and depreciation rates do not affect the size of the investment. For revenue-neutral incentive packages, the effect of changes in the above variables on the investment timing and size is not necessarily monotonic and it depends on the instrument of the tax-subsidy policy that is used to keep the new policy revenue neutral. There are also economic contexts in which an increase in the tax rate can accelerate investments of a larger scale.

Keywords: Capacity choice; Investment subsidy; Real options; Taxation policy; Uncertainty (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1016/j.omega.2020.102312

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