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Durable vs. disposable equipment choice under interest rate uncertainty

Author

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  • Jose Carlos Dias
  • Mark Shackleton

Abstract

This article analyzes present value costs under stochastic interest rates and investigates the effect of interest rate uncertainty on the replacement investment decision that a firm must make when a piece of equipment becomes obsolete and needs replacement with either short- or long-lived equipment. We consider the replacement problem under stochastic interest rates in a CIR economy (Cox, Ingersoll, and Ross 1985a,b). Depending on the interest rate levels, interest rate volatility and the optionality to switch between durable and expendable assets at each renewal time, managers may prefer to invest in long-lived but more expensive assets instead of short-lived but less costly assets and vice versa.

Suggested Citation

  • Jose Carlos Dias & Mark Shackleton, 2009. "Durable vs. disposable equipment choice under interest rate uncertainty," The European Journal of Finance, Taylor & Francis Journals, vol. 15(2), pages 157-167.
    • Handle: RePEc:taf:eurjfi:v:15:y:2009:i:2:p:157-167
    DOI: 10.1080/13518470802560790
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    Cited by:

    1. Dias, José Carlos & Shackleton, Mark B., 2011. "Hysteresis effects under CIR interest rates," European Journal of Operational Research, Elsevier, vol. 211(3), pages 594-600, June.

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