INVESTMENT UNDER UNCERTAINTY - THE CASE OF REPLACEMENT INVESTMENT DECISIONS

We analyze the determinants of replacement investment decisions in a c ontingent claims model with maintenance and operation cost uncertainty . We find that the optimal time between replacements is increasing in the volatility of cost, the purchase price of a new asset, and the cor porate tax rate; and is decreasing in the systematic risk of cost, the salvage value of the asset, and the investment tax credit. The optima l time between replacements can either increase or decrease with an in crease in the depreciation rate, Extensions of the model to examine th e effects of technological and tax policy uncertainty on replacement i nvestment decisions give intuitive, but striking results. Uncertainty about the arrival of a technological innovation that would decrease ma intenance and operation cost results in a significant decrease in repl acement investment. Uncertainty in a tax law change that would encoura ge investment decreases current investment; and uncertainty in a tax l aw change that would discourage investment increases current investmen t.