Investment Timing When Investment Opportunities Arrive In A Random Sequence
This paper considers a ﬁrm’s optimal investment timing problem when investment opportunities arrive in a random sequence and are irreversible. We analytically derive the project value and the investment threshold. The solutions converge to those of the real option value (ROV) method as the arrival rate of investment opportunities is higher, whereas the solutions converge to those of the net present value (NPV) method as the arrival rate of investment opportunities is lower. Further, we extend the results to a case with two project types, namely good and bad types. We analytically derive the condition un-der which the ﬁrm always forgoes bad-type projects. A notable result is that the ﬁrm accepts a bad-type project for a low arrival rate and a high state variable. Our results reveal the eﬀects of illiquidity on real option valuation and build a bridge between the NPV and ROV methods.