Options, the value of capital, and investment
Capital investment decisions must recognize the limitations on the firm's ability to later sell or expand capacity. This paper shows how opportunities for future expansion or contraction can be valued as options, how their valuation relates to the q theory of investment, and their effect on the incentive to invest. Generally, the option to expand reduces the incentive to invest, while the option to disinvest raises it. The authors show how these options determine the effect of uncertainty on investment, how they are changed by shifts of the distribution of future profitability, and how the q-theory and option pricing approaches are related. Coauthors are Avinash K. Dixit, Janice C. Eberly, and Robert S. Pindyck. Copyright 1996, the President and Fellows of Harvard College and the Massachusetts Institute of Technology.
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