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Renewing Assets with Uncertain Revenues and Operating Costs

Published online by Cambridge University Press:  22 December 2010

Roger Adkins  and
Dean Paxson
Roger Adkins
Affiliation:
School of Management, University of Bradford, Emm Lane, Bradford BD9 4JL, UK. [email protected]
Dean Paxson
Affiliation:
Manchester Business School, University of Manchester, Booth Street West, Manchester M15 6PB, UK. [email protected]
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Abstract

We study optimal replacement and abandonment decisions for real assets, when both revenues and costs are uncertain and deteriorate with age. We develop an implicit representation of the renewal boundary as the solution to a set of simultaneous equations. This quasi-analytical method has the merit of computational ease and transparency. We show that the correlation between revenues and operating costs has a significant influence on the renewal boundary, and that the increase in revenue immediately following a renewal has a greater relative influence on the boundary than either operating cost or renewal cost. The quasi-analytical method is sufficiently flexible to deal with other real option models involving 2 variables.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 46 , Issue 3 , June 2011 , pp. 785 - 813
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2011

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