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Options, the Value of Capital, and Investment

Andrew Abel (), Avinash Dixit (), Janice Eberly () and Robert Pindyck ()

Rodney L. White Center for Financial Research Working Papers from Wharton School Rodney L. White Center for Financial Research

Abstract: Capital investment decisions must recognize the limitations on the firm’s ability to later sell off or expand capacity. This paper shows how opportunities for future expansion or contraction can be valued as options, how this valuation relates to the q-theory of investment, and how these options affect the incentive to invest. Generally, the option to expand reduces the incentive to invest, while the option to disinvest raises it. We show how these options interact to determine the effect of uncertainty on investment, how these option values change in response to shifts of the distribution of future profitability, and how the q-theory and option pricing approaches to investment are related.

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Related works:
Journal Article: Options, the Value of Capital, and Investment (1996) Downloads
Working Paper: Options, the value of capital, and investment (1995) Downloads
Working Paper: Options, the Value of Capital, and Investment (1995) Downloads
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