Production, Finance and Investment When Demand is Uncertain
In the previous chapters the firm’s optimal policy was studied within a deterministic framework. In this chapter we explicitly deal with uncertainty by introducing a Gaussian stochastic variable in the sales function. Because the future sales rate is uncertain it may happen that sales suddenly fall below the expenses level, where expenses consist of dividend payments and investment, implying the occurrence of net cash outflows. Therefore a certain amount of cash is needed to meet the firm’s expenses during such periods. If at a certain point of time the stock of cash is below the expenses level the firm goes bankrupt. This moment fixes the planning horizon after which no dividend will be paid out. In this way the planning horizon is endogenously determined, because, for example, more cash implies less risk on bankruptcy which implies a longer planning period and thus a longer period of possible dividend payout. Hence, if the level of future sales is uncertain the firm’s cash management is an important aspect of the firm’s policy. In deterministic models there is no reason to keep cash, because (operating and investment) expenses can be planned such that they never exceed future (known) sales. Therefore the variable that specifies the “stock of cash” did not appear in the previous chapters in this book.
KeywordsPlanning Horizon Capital Good Dividend Payment Previous Chapter Stochastic Dynamic Programming
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