Strategic Capital Budgeting: Asset Replacement Under Uncertainty
AbstractWe consider a firm's decision to replace an existing production technology with a new, more cost-efficient one.Kulatilaka and Perotti [1998, Management Science] nd that, in a two-period model, increased product market uncertainty could encourage the firm to invest strategically in the new technology.This paper extends their framework to a continuous-time model which adds flexibility in timing of the investment decision.This flexibility introduces an option value of waiting which increases with uncertainty.In contrast with the two-period model, despite the existence of the strategic option of becoming a market leader due to a lower marginal cost, more uncertainty always increases the expected time to invest.Furthermore, it is shown that under increased uncertainty the probability that the firm finds it optimal to invest within a given time period always decreases for time periods longer than the optimal time to invest in a deterministic case.For smaller time periods there are contrary effects so that the overall impact of increased uncertainty on the probability of investing is in this case ambiguous.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2001-4.
Date of creation: 2001
Date of revision:
Contact details of provider:
Web page: http://center.uvt.nl
capital budgeting; uncertainty; investment; game theory;
Other versions of this item:
- Kort, P.M. & Pawlina, G., 2003. "Strategic capital budgeting: Asset replacement under uncertainty," Open Access publications from Tilburg University urn:nbn:nl:ui:12-123062, Tilburg University.
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2001-02-08 (All new papers)
- NEP-CFN-2001-02-08 (Corporate Finance)
- NEP-FIN-2001-02-08 (Finance)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Nalin Kulatilaka & Enrico C. Perotti, 1998. "Strategic Growth Options," Management Science, INFORMS, vol. 44(8), pages 1021-1031, August.
- Anonymous, 1998. "For the record: September - December 1998," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 61, December.
- Fudenberg, Drew & Tirole, Jean, 1985. "Preemption and Rent Equilization in the Adoption of New Technology," Review of Economic Studies, Wiley Blackwell, vol. 52(3), pages 383-401, July.
- Décamps, Jean-Paul & Mariotti, Thomas, 2000.
"Irreversible Investment and Learning Externalities,"
IDEI Working Papers
97, Institut d'Économie Industrielle (IDEI), Toulouse.
- Decamps, J.-P. & Mariotti, T., 2000. "Irreversible Investment and Learning Expternalities," Papers 00-534, Toulouse - GREMAQ.
- Robin Mason & Helen Weeds, 2000.
"Networks, Options and Preemption,"
Econometric Society World Congress 2000 Contributed Papers
1721, Econometric Society.
- Mason, R. & Weeds, H., 2000. "Networks, options and preemptions," Discussion Paper Series In Economics And Econometrics 0013, Economics Division, School of Social Sciences, University of Southampton.
- Mason, R. & Weeds, H., 2000. "Networks, Options and Preemption," The Warwick Economics Research Paper Series (TWERPS) 575, University of Warwick, Department of Economics.
- Grenadier, Steven R, 1996. " The Strategic Exercise of Options: Development Cascades and Overbuilding in Real Estate Markets," Journal of Finance, American Finance Association, vol. 51(5), pages 1653-79, December.
- Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, January.
- McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
- Lambrecht, Bart & Perraudin, William, 2003. "Real options and preemption under incomplete information," Journal of Economic Dynamics and Control, Elsevier, vol. 27(4), pages 619-643, February.
- Han T. J. Smit & L. A. Ankum, 1993. "A Real Options and Game-Theoretic Approach to," Financial Management, Financial Management Association, vol. 22(3), Fall.
- Huisman, K.J.M. & Kort, P.M., 1999. "Effects of Strategic Interactions on the Option Value of Waiting," Discussion Paper 1999-92, Tilburg University, Center for Economic Research.
- Enrico Perotti & Silvia Rossetto, 2000. "Internet Portals as Portfolios of Entry Options," Tinbergen Institute Discussion Papers 00-105/2, Tinbergen Institute.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Richard Broekman).
If references are entirely missing, you can add them using this form.