Premium
Investment Timing for Dynamic Business Expansion
Author(s) -
Blazenko George W.,
Pavlov Andrey D.
Publication year - 2009
Publication title -
financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.647
H-Index - 68
eISSN - 1755-053X
pISSN - 0046-3892
DOI - 10.1111/j.1755-053x.2009.01058.x
Subject(s) - investment (military) , earnings , economics , rate of return , returns to scale , return on investment , deferral , capital (architecture) , return of capital , monetary economics , microeconomics , econometrics , investment performance , finance , production (economics) , archaeology , politics , political science , law , history
We investigate the timing of business expansion. With an indefinite sequence of growth opportunities that have constant returns to scale, current investment neither displaces nor impairs future returns. In a dynamic setting with expansion restricted to a fraction of firm size, the endogenously determined cost of capital uniformly exceeds the value maximizing return threshold for expansion. Taking this into account, a manager accelerates investment to facilitate larger and more valuable future investments when earnings stochastically improve. This result is the opposite of deferral that the investment literature recommends due to irreversibility. This means that the managerial application of the cost of capital as an expansion hurdle rate is improperly conservative.