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Cambridge Finance Seminar - Wang Neng

When May 15, 2014
from 05:00 PM to 06:00 PM
Where Bridgetower Room, Trinity Hall
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The Cambridge Finance Seminar

Thursday 15th May


Bridgetower Room, Trinity Hall


Professor Wang Neng

Colombia University


Investment, Liquidity, and Financing under Uncertainty


We develop a real options model for a financially constrained firm. Facing external financing costs, the firm prefers to fund its investment through internal funds, so that the firm's optimal investment policy and its value depend on the size of its liquidity holdings. We show that financial constraints significantly alter the standard real options results. Importantly, the investment hurdle is highly non-monotonic in the firm's internal funds as the firm may prefer accumulating internal funds rather than accessing costly external capital markets when internal funds are sufficiently high. Additionally, the firm's external equity issue is non-monotonic in its liquidity holdings. With multiple rounds of growth options, a value-maximizing financially constrained firm may choose to exercise its growth option sooner that the first-best level in earlier stages in order to mitigate delayed growth option exercising in later stages. Our analysis brings out the rich and subtle interactions between sources of funds (external, internal, and endogenous retained earnings) and the optimal exercising of investment and abandonment options.   


Refreshments will be provided.


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