8.11. (This follows Bernanke, 1983a, and Dixit and Pindyck, 1994.) Consider a firm that is contemplating undertaking an investment with a cost of I. There are two periods. The investment will pay off, in period 1 and 2 in period 2. is certain, but 2 is uncertain. The firm maximizes expected profits and, for simplicity, the interest rate is zero.

(a) Suppose the firm's only choices are to undertake the investment in period 1 or not to undertake it at all. Under what condition will the firm undertake the investment?

(b) Suppose the firm also has the possibility of undertaking the investment in period 2, after the value of 2 is known; in this case the investment pays off only 2. Is it possible for the firm's expected profits to be higher if it does not invest in period 1 than if it does even if the condition in

(a) is satisfied?

(c) Define the cost of waiting as m, and define the benefit of waiting as 

Explain why these represent the cost and the benefit of waiting. Show that the difference in the firm's expected prof- its between not investing in period 1 and investing in period 1 equals the benefit of waiting minus the cost.

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