INVESTMENTS OF UNCERTAIN COST

This paper examines irreversible investment decisions when projects ta ke time to complete and are subject to two types of cost uncertainty. The first is technical uncertainty, i.e., uncertainty over the physica l difficulty of completing a project, which is only resolved as the in vestment proceeds. The second is input cost uncertainty, i.e., uncerta inty over the prices of construction inputs or over government regulat ions affecting construction costs, which is external to the firm. Thes e two types of uncertainty have very different effects on the investme nt decision. A simple investment rule is derived that maximizes firm v alue, and is used to analyze the decision to start or continue buildin g a nuclear power plant during the 1980s.