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The effects of external financing costs on investment timing and sizing decisions

  • Michi NISHIHARA

    ()

    (Graduate School of Economics, Osaka University)

  • Takashi SHIBATA

    ()

    (Graduate School of Social Sciences, Tokyo Metropolitan University)

We 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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File URL: http://www2.econ.osaka-u.ac.jp/library/global/dp/1207.pdf
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Paper 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.

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Length: 31 pages
Date of creation: Apr 2012
Date of revision:
Handle: RePEc:osk:wpaper:1207
Contact details of provider: Web page: http://www.econ.osaka-u.ac.jp/
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