Abstract
This paper integrates endogenous discounting with the standard q theory of investment (Abel & Eberly, 1994; Hayashi, 1982). It shows that time-varying discount rate has significant effects on discouraging investment and lowering firm value via capital stock. Marginal q is not equal to average q in the endogenous discounting settings, contrary to the conventional wisdom. By decomposing a firm into assets in place and growth opportunities, we find that the value of assets in place is increasing in capital stock but the value of growth opportunities is nonmonotonic with capital stock. Furthermore, we extend the model to allow for endogenous capital liquidation and macroeconomic conditions.
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