Abstract
Investment decisions are often characterized by uncertainty, irreversibility, and timing flexibility. We use a binomial model to investigate the interdependencies of effects from profit taxation and both an option to delay and an option to abandon on investment decisions. We show that increasing the tax rate can lead to paradoxical tax effects, i.e. it may foster an investor’s willingness to invest. By contrast, if we abstract from the abandonment option, such paradoxical effects cannot be identified. Hence, we show that paradoxical tax effects can be caused by an abandonment option. Our results are helpful for investors facing risky investment opportunities and for improving typical valuation approaches.
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