Capital investment by risk neutral agents: Merging adjustment costs and irreversibility

Current capital investment affects future investment by setting conditions upon which a firm makes future investment decisions. This analysis applies option pricing theory to capital investment in order to determine possibilities of future investment, and shows the optimal investment choice for a firm contemplating future investment. The theoretical analysis develops a model for capital investment by risk neutral agents. The model includes costly reversibility and fixed costs of investment. Then, numerical analysis shows that optimal investment is approximately linear in economic parameters such as the discount rate. Empirical analysis shows that actual investment behaves as theoretical analysis predicts.