Investment Timing for Dynamic Business Expansion |
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| Authors: | George W. Blazenko Andrey D. Pavlov |
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| Affiliation: | 1. George W. Blazenko is a Professor of Finance at Simon Fraser University in Burnaby, British Columbia.;2. Andrey D. Pavlov is a visiting Associate Professor of Real Estate at the University of Pennsylvania, Philadelphia, PA and an Associate Professor of Finance at Simon Fraser University in Burnaby, British Columbia, Canada. |
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| Abstract: | 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. |
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