The effects of external financing costs on investment timing and sizing decisions
AbstractWe develop a dynamic model in which a firm exercises an option to expand production on either a small or large scale with cash reserves and costly external funds. We show that the financing costs greatly distort the firmfs financing and investment behavior and result in a policy contingent on the dynamics of the cash flow and reserves. Most notably, we prove that an intermediate level of cash reserves is likely to accelerate investment in the small-scale project by interactions among financing costs, investment timing, and investment sizing. Our results fill the gap between two types of results: (i) empirical findings in a U-shaped relation between the investment volume and internal funds, and (ii) empirical predictions of a U-shaped relation between the investment timing and internal funds.
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Bibliographic InfoPaper provided by Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP) in its series Discussion Papers in Economics and Business with number 12-07.
Length: 31 pages
Date of creation: Apr 2012
Date of revision:
Investment timing; Investment size; Costly external financing; Optimal stopping;
Find related papers by JEL classification:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-04-23 (All new papers)
- NEP-DGE-2012-04-23 (Dynamic General Equilibrium)
- NEP-FDG-2012-04-23 (Financial Development & Growth)
- NEP-MAC-2012-04-23 (Macroeconomics)
- NEP-PBE-2012-04-23 (Public Economics)
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