Abstract
We study an optimal investment policy of a risky project when there exists the possibility that a firm may permanently exit the business under deeply deteriorated market conditions in the future. To capture the riskiness of the investment return rate, a Geometric Brownian motion is adopted to model the firm’s profit stream. Applying the real options framework, this paper aims at characterizing the firm’s optimal investment policy of the risky project under permanent exit option. It is shown that the investment threshold is no longer a monotonic function of the market uncertainty. Specifically, the investment threshold can decrease with market uncertainty for moderate uncertainty. And the investment threshold will eventually increase with market uncertainty if the uncertainty becomes sufficiently high. Extensive numerical experiments are conducted to check the robustness of the theoretic results. Some managerial implications are derived for investment decisions under the exit option.
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Acknowledgements
This work of J. Ni was supported by the National Natural Science Foundation of China (NSFC) (Grant No. 71601159), this work of J. W. Wang was supported by the National Natural Science Foundation of China (NSFC) (Grant No. 71571156) and the open project funded by State Key Laboratory of Synthetical Automation for Process Industries (PAL-N201505), this work of L.K. Chu was supported by the University of Hong Kong Small Project Funding (201409176228), and this work of C. D. Li was supported by the National Natural Science Foundation of China (NSFC) (Grant No. 71672074).
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Li, Q., Wang, J., Ni, J. et al. The optimal time to make a risky investment under a permanent exit option. J Intell Manuf 30, 2669–2680 (2019). https://doi.org/10.1007/s10845-017-1299-1
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DOI: https://doi.org/10.1007/s10845-017-1299-1