scholarly journals Missed Opportunities: Optimal Investment Timing When Information is Costly

2007 ◽  
Vol 42 (2) ◽  
pp. 467-488 ◽  
Author(s):  
Graeme Guthrie
Keyword(s):  
Real World ◽  
Real Option ◽  
Optimal Investment ◽  
Investment Opportunity ◽  
Missed Opportunities ◽  
Investment Timing ◽  
Real Option Analysis ◽  
Amount Of Information ◽  
Optimal Delay

AbstractReal option analysis typically assumes that projects are continuously evaluated and launched at precisely the time determined to be optimal, but real world projects cannot be managed in this way because of the costs of formally evaluating an investment opportunity. This paper shows that immediate investment is more attractive if evaluation costs are high or the amount of information to be revealed by an evaluation is large. The optimal delay until a reevaluation is long if evaluation costs are high or the amount of information to be revealed by an evaluation is small. The reduction in the value of project rights is especially severe when the value of the completed project is strongly mean reverting because then precision in investment timing is particularly important.

scholarly journals A framework for modelling cash flow lags

2021 ◽  
Vol 1 (10) ◽  
Author(s):  
Fredrik Armerin ◽  
Han-Suck Song
Keyword(s):  
Cash Flow ◽  
Real World ◽  
Optimal Investment ◽  
Cash Flows ◽  
Investment Timing ◽  
Time To Build ◽  
Time Periods ◽  
Future Cash Flows ◽  
Natural Way

AbstractTraditional models of irreversible investment problems assume that the investment starts generating cash flows immediately, i.e., at the same time as the investment is undertaken. Real-world investment situations are characterized by time-to-build or investment lags, which means that there is a time difference between when the investment is made and when the investment starts generating cash flows. We combine two existing models of investment lags to obtain a flexible, yet simple, way of modelling and analyzing the effects of investment lags. Both traditional models, and models that incorporate the effects of time-to-build, typically assume that the expected future cash flows generated by an investment are represented by a single cash flow that reflects the size of the market value of an investment. To reflect real-world cases where investments generate cash flows in several time periods, we present a framework in which cash flows are explicitly allowed to be spread out in time. Our model can be used to incorporate cases where an investment is partially sold in different time periods. Using an irreversible optimal investment timing problem case study, we show how our framework makes it possible to easily compare the effect of different cash flow timings. In this case, the value and the timing of the investment depend on a constant that in a natural way can be decomposed into three parts, thereby showing the influence of the value and timing from the respective parts of the framework.

REAL OPTION SIGNALING GAMES OF DEBT FINANCING USING EQUITY GUARANTEE SWAPS UNDER ASYMMETRIC INFORMATION

2020 ◽  
Vol 23 (05) ◽  
pp. 2050036
Author(s):  
QIUQI WANG ◽  
YUE KUEN KWOK
Keyword(s):  
Real Option ◽  
Debt Financing ◽  
Bank Loan ◽  
Information Cost ◽  
Information Costs ◽  
Investment Opportunity ◽  
High Type ◽  
Investment Timing ◽  
Funding Cost ◽  
Financing Choice

We analyze the real option signaling game models of debt financing of a risky project under information asymmetry, where the firm quality is only known to the firm management but not outsiders. The firm decides on the optimal investment timing of the risky project that requires upfront fixed funding cost and subsequent operating costs. The fixed funding cost is financed via either direct bank loan or entering into a three-party equity guarantee swap (EGS) that involves a bank granting the loan and third party guarantor. Under the EGS agreement, the guarantor is obligated to pay all the future coupon stream to the bank upon default of the firm. In return for the provision of the guarantee, the guarantor obtains certain proportional share of equity of the firm at the time when the swap agreement is signed. The share of equity demanded by the guarantor depends on the outside investors’ belief on the firm quality. The low-type firm has the incentive to mimic the investment strategy of being high-type in terms of investment timing and share of equity. The high-type firm may adopt the appropriate separating strategy by speeding up investment or choosing an alternative financing choice. The resulting loss of the real option value of the investment opportunity represents the information cost under separating strategies. We examine the incentive compatibility constraints faced by the firm under different quality types and discuss characterization of the separating and pooling equilibriums. Unlike the usual assumption of perpetuity of investment opportunity, our real option model assumes the time window of the investment opportunity to be finite. We explore how the information cost and nature of separating and pooling equilibriums evolves over the finite time span of the investment opportunity. The information costs and investment thresholds exhibit interesting time-dependent behaviors. We examine the firm’s investment and financing choice between EGS and the direct bank loan against time and other parameters via comparison of the corresponding information costs and investment thresholds.

scholarly journals The Effects of Abandonment Options on Investment Timing and Profit Sharing of FDI

2017 ◽  
Vol 2017 ◽  
pp. 1-11
Author(s):  
Weiwei Zhang ◽  
Minggao Xue
Keyword(s):  
Foreign Direct Investment ◽  
Direct Investment ◽  
Real Option ◽  
Optimal Investment ◽  
International Investment ◽  
Profit Sharing ◽  
Negative Effects ◽  
Investment Timing ◽  
Real Option Method ◽  
Profit Share

The paper incorporates cooperative game theory into a real option method in a foreign direct investment setting and examines the operational decisions of a multinational corporation in a cooperative framework, where the corporation is endowed with an abandonment option and shares its profit with the host country. In particular, we investigate how the abandonment options affect the optimal investment timing and the optimal profit share of a foreign direct investment using a real option game method. We show that the flexibility of the abandonment option induces the corporation to investment earlier, which indicates the negative effects on investment trigger. The result is consistent with intuition since the abandonment option provides insurance and thus reduces the overall risk of the project. We also find that the introduction of the abandonment option reduces the optimal profit share in a cooperative framework and in turn the lower profit share increases the investment trigger, thereby having a positive effect on the investment threshold to hinder the investment. By numerical analysis, we find that the overall effect of the abandonment options is inversely related to the investment trigger. These findings provide quantitative analysis about the decisions regarding cooperation in international investment extraction projects.

scholarly journals Optimal Investment and Financial Strategies under Tax-Rate Uncertainty

2011 ◽  
Vol 12 (4) ◽  
pp. 438-468
Author(s):  
Alessandro Fedele ◽  
Sergio Vergalli ◽  
Paolo M. Panteghini
Keyword(s):  
Real Option ◽  
Relevant Literature ◽  
Optimal Investment ◽  
Tax Rate ◽  
Investment Timing ◽  
Investment Projects ◽  
Debt Finance ◽  
Option Model ◽  
Financial Strategies ◽  
Representative Firm

AbstractIn this paper, we apply a real-option model to study the effects of tax-rate uncertainty on a firm’s decision. In doing so, we depart from the relevant literature, which focuses on fully equity-financed investment projects. By letting a representative firm borrow optimally, we show that debt finance not only encourages investment activities but can also substantially mitigate the effect of tax-rate uncertainty on investment timing.

A jump-diffusion real option approach for hotel investment under uncertain lodging demand

Kybernetes ◽  
2016 ◽  
Vol 45 (10) ◽  
pp. 1604-1616 ◽  
Author(s):  
Rufei Ma ◽  
Pengxiang Zhai
Keyword(s):  
Real Option ◽  
Economic Recession ◽  
Optimal Investment ◽  
Jump Diffusion ◽  
Discounted Cash Flow ◽  
Content Type ◽  
Investment Timing ◽  
Real Option Approach ◽  
Hotel Investment ◽  
The Impact

Purpose One of the important characteristics of the hotel business is uncertainty of lodging demand, which can jeopardize hotel operation and ultimately even threaten a hotel’s survival during an economic recession. The purpose of this paper is to propose an approach to determine optimal hotel investment issues under uncertain lodging demand. Design/methodology/approach Uncertainty of lodging demand is classified into two types: the impact of unexpected economic recession and the temporary imbalance between supply of hotel rooms and lodging demand. A jump-diffusion real option approach is proposed to analyze how these two types affect optimal investment timing and the potential value of new hotel projects. The case of hotel investment in Macao is used to illustrate the jump-diffusion real option approach. Findings The results of numerical analysis show that the uncertainty induced by temporary imbalance between supply of hotel rooms and lodging demand increases the threshold of investment and hotel value, while the uncertainty induced by unexpected economic recession has ambiguous effects on the value and optimal investment timing of new hotel projects. Practical implications The jump-diffusion real option approach increases managerial flexibility for managers when making investment decisions on new hotel projects, allowing greater value to be generated than is possible with the conventional discounted cash flow method. Originality/value The approach separates the impact of unexpected economic recession on lodging demand from that of “normal” fluctuations in lodging demand, and it considers the impact of both types of uncertainty on hotel investment.

scholarly journals INVESTMENT TIMING UNDER REGIME SWITCHING

2009 ◽  
Vol 12 (04) ◽  
pp. 443-463 ◽  
Author(s):  
ROBERT J. ELLIOTT ◽  
HONG MIAO ◽  
JIN YU
Keyword(s):  
Regime Switching ◽  
Real Option ◽  
Optimal Investment ◽  
Optimal Timing ◽  
Investment Timing ◽  
Investment Opportunities ◽  
Investment Cost ◽  
State Of The Economy ◽  
Information Sets ◽  
Option Model

We investigate the optimal investment timing strategy in a real option framework. Depending on the state of the economy, whose changes are modeled by a Markov chain, the investment cost can take one of two values. The optimal investment timing decision is determined by finding the free boundary of a perpetual American option. Three investment timing policies, based on different assumptions of investors' information sets, are determined and compared. In the full information case, a significantly earlier optimal exercising time is indicated. We show that an optimal-timing policy suggested by the conventional real option model might ruin the investment opportunities.

scholarly journals Optimal Investment Timing and Size of a Logistics Park: A Real Options Perspective

Complexity ◽  
2017 ◽  
Vol 2017 ◽  
pp. 1-12 ◽  
Author(s):  
Dezhi Zhang ◽  
Jiehui Jiang ◽  
Shuangyan Li ◽  
Xiamiao Li ◽  
Qingwen Zhan
Keyword(s):  
Real Options ◽  
Real Option ◽  
Net Present Value ◽  
Optimal Investment ◽  
Optimal Timing ◽  
Logistics Park ◽  
Investment Timing ◽  
Government Subsidies ◽  
Investment Size ◽  
Logistics Demand

This paper uses a real options approach to address optimal timing and size of a logistics park investment with logistics demand volatility. Two important problems are examined: when should an investment be introduced, and what size should it be? A real option model is proposed to explicitly incorporate the effect of government subsidies on logistics park investment. Logistic demand that triggers the threshold for investment in a logistics park project is explored analytically. Comparative static analyses of logistics park investment are also carried out. Our analytical results show that (1) investors will select smaller sized logistics parks and prepone the investment if government subsidies are considered; (2) the real option will postpone the optimal investment timing of logistics parks compared with net present value approach; and (3) logistic demands can significantly affect the optimal investment size and timing of logistics park investment.

scholarly journals Optimal Investment Timing and Scale Choice of Overseas Oil Projects: A Real Option Approach

Energies ◽  
2018 ◽  
Vol 11 (11) ◽  
pp. 2954 ◽  
Author(s):  
Jia-Yue Huang ◽  
Yun-Fei Cao ◽  
Hui-Ling Zhou ◽  
Hong Cao ◽  
Bao-Jun Tang ◽  
...  
Keyword(s):  
Real Option ◽  
Oil Prices ◽  
Optimal Investment ◽  
Oil Price ◽  
Uncertain Environments ◽  
Investment Timing ◽  
Oil Companies ◽  
Geological Conditions ◽  
Real Option Approach ◽  
The Impact

This article presents a real option model for helping investors to determine the optimal investment timing and scale of overseas oil projects. The model is suitable for the highly uncertain environments in which many oil companies operate, where they have to suspend upstream investment, stop new oilfield construction, and wait for proper oil prices in order to avoid losses. Considering the uncertainty of oil prices and exchange rates, the results of analytical solutions presented in this paper show the critical oil price that can be seen as the investment threshold for triggering oilfield development as well as the optimal recoverable factor for every oil price level to indicate the optimal investment scale. Results of the case project show the critical oil price, which is 82.32 US dollar per barrel, and the selection of optimal investment scale. The article also demonstrates the impact of investment scale on investment timing in overseas oil projects. The policy implication from the case project is that investment decisions are finitely impacted by geological conditions. Besides, the existence of tax holiday directly contributes to a lower investment threshold. In addition, reducing unit operation cost can obviously enlarge optimal investment scale and initiate oil projects in a relatively low level of investment threshold.

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