I study irreversible investment decisions when projects take time to complete, and are subject to two types of uncertainty over the cost of completion. The first is technical uncertainty, i.e., uncertainty over the amount of time, effort, and materials that will ultimately be required to complete the project, and that is only resolved as the investment proceeds. The second is input cost uncertainty, i.e., uncertainty over the prices and quantities of labor and materials required, and which is external to the firm's investment activity. I derive a simple decision rule that maximizes the firm's value, and I use it to show how these two types of uncertainty have very different effects on investment decisions. As an example. I analyze the decision to start or continue building a nuclear power plant during the 1980's.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
4175.
Length: Date of creation: Nov 1993 Date of revision: Handle: RePEc:nbr:nberwo:4175
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Find related papers by JEL classification: G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis
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