Strategic Capital Budgeting

Asset Replacement Under Uncertainty

G. Pawlina, P.M. Kort

Research output: Working paperDiscussion paperOther research output

219 Downloads (Pure)

Abstract

We 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.
Original languageEnglish
Place of PublicationTilburg
PublisherFinance
Number of pages27
Volume2001-4
Publication statusPublished - 2001

Publication series

NameCentER Discussion Paper
Volume2001-4

Fingerprint

Uncertainty
Assets
Capital budgeting
Replacement
Investing
Marginal cost
Production technology
Investment decision
Cost uncertainty
Long period
Product market
Management science
Continuous-time model
Strategic options
Market uncertainty
Option value
Costs

Keywords

  • capital budgeting
  • uncertainty
  • investment
  • game theory

Cite this

Pawlina, G., & Kort, P. M. (2001). Strategic Capital Budgeting: Asset Replacement Under Uncertainty. (CentER Discussion Paper; Vol. 2001-4). Tilburg: Finance.
Pawlina, G. ; Kort, P.M. / Strategic Capital Budgeting : Asset Replacement Under Uncertainty. Tilburg : Finance, 2001. (CentER Discussion Paper).
@techreport{e79e30d8bf354cdeae02f327bd23f381,
title = "Strategic Capital Budgeting: Asset Replacement Under Uncertainty",
abstract = "We 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.",
keywords = "capital budgeting, uncertainty, investment, game theory",
author = "G. Pawlina and P.M. Kort",
note = "Pagination: 27",
year = "2001",
language = "English",
volume = "2001-4",
series = "CentER Discussion Paper",
publisher = "Finance",
type = "WorkingPaper",
institution = "Finance",

}

Pawlina, G & Kort, PM 2001 'Strategic Capital Budgeting: Asset Replacement Under Uncertainty' CentER Discussion Paper, vol. 2001-4, Finance, Tilburg.

Strategic Capital Budgeting : Asset Replacement Under Uncertainty. / Pawlina, G.; Kort, P.M.

Tilburg : Finance, 2001. (CentER Discussion Paper; Vol. 2001-4).

Research output: Working paperDiscussion paperOther research output

TY - UNPB

T1 - Strategic Capital Budgeting

T2 - Asset Replacement Under Uncertainty

AU - Pawlina, G.

AU - Kort, P.M.

N1 - Pagination: 27

PY - 2001

Y1 - 2001

N2 - We 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.

AB - We 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.

KW - capital budgeting

KW - uncertainty

KW - investment

KW - game theory

M3 - Discussion paper

VL - 2001-4

T3 - CentER Discussion Paper

BT - Strategic Capital Budgeting

PB - Finance

CY - Tilburg

ER -

Pawlina G, Kort PM. Strategic Capital Budgeting: Asset Replacement Under Uncertainty. Tilburg: Finance. 2001. (CentER Discussion Paper).