Exercise 2 Consider a firm that is not currently producing, but has the option t

Question

Exercise 2 Consider a firm that is not currently producing, but has the option to invest at a sunk cost I 0 to start production in return for an uncertain revenue stream Y where the dynamics of Y follow the geometric Brownian motion given by Further assume that production entails a constant marginal cost of c >0 per period. What is the value of the option to invest? Now consider the situation whereby the firm has invested, and now possesses the option to abandon (or shut down) production by incurring a sunk cost E, such that 0

Explanation / Answer

Consider a firm that is not currently producing, but has the option to invest at a sunk costin order to start the production. So this question doesnt relate to operational management.

This question is related to economics not operational management.

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