Technological advances and the decision to invest

Christian Flor and Simon Hansen

Annals of Finance, 2013, vol. 9, issue 3, 383-420

Abstract: Technological advances impact a firm’s investment decision, as they affect the investment cost. They can also affect the profitability due to demand shocks. We study a firm’s optimal investment decision when technological advances occur as surprises and induce uncertain reductions in the investment cost and in earnings. Despite this complex setting we derive closed-form solutions for the investment option value and the investment threshold. When technological advances only impact the investment cost, we demonstrate significant contributions compared to existing research, which restricts the analysis by keeping the expected investment cost path constant. For example, we show that, albeit the investment threshold is constant, the option value is very sensitive in the expected impact of technological advances. Leaving the restrictive setting, we obtain more intuitive results, e.g. that more frequent technological advances increase the option value. When technological advances impact future earnings we find important long-term effects: the investment threshold increases, whereas the option value decreases. Finally, earnings volatility postpones investment, while uncertainty due to technological advances expedites investment. Copyright Springer-Verlag 2013

Keywords: Optimal investment; Price uncertainty; Cost uncertainty; Real options; Shocks; G31; D81 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:kap:annfin:v:9:y:2013:i:3:p:383-420

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DOI: 10.1007/s10436-012-0191-4

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