Investment under Uncertainty with Variable Costly Reversibility

Abstract

We examine the optimal investment timing and quantity decisions problem when a firm can determine the costly reversible ratio of investment endogenously at the time of stopping project operation. We obtain two important results. First, when the costless reversible ratio increases, the price volatility increases, the fixed cost of investment increases, and the cost of costly reversibility becomes more efficient, but the firm is more likely to undertake the costly reversible strategy. Second, when the firm undertakes the costly reversible strategy, the investment quantity is always increased, but the investment timing (trigger) is not always accelerated (decreased). We then show that the effects of endogenous costly reversibility are quite different from those of exogenous costless reversibility. These results fit well with those of previous empirical studies.