Abel, Andrew BDixit, Avinash KEberly, Janice CPindyck, Robert S2023-05-222023-05-2219962016-06-17https://repository.upenn.edu/handle/20.500.14332/34355Capital investment decisions must recognize the limitations on the firm's ability to later sell or expand capacity. This paper shows how opportunities for future expansion or contraction can be valued as options, how their valuation relates to the q theory of investment, and their effect on the incentive to invest. Generally, the option to expand reduces the incentive to invest, while the option to disinvest raises it. We show how these options determine the effect of uncertainty on investment, how they are changed by shifts of the distribution of future profitability, and how the q-theory and option pricing approaches are related.This is a pre-copyedited, author-produced PDF of an article accepted for publication in The Quarterly Journal of Economics following peer review. The version of record is available online at: http://dx.doi.org/10.2307/2946671.FinanceFinance and Financial ManagementArticle