Abstract

http://ssrn.com/abstract=227193
 
 

References (23)



 
 

Citations (74)



 
 

Footnotes (21)



 


 



Time to Build, Option Value, and Investment Decisions


Saman Majd


University of Pennsylvania Wharton School

Robert S. Pindyck


Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

June 1985

NBER Working Paper No. w1654

Abstract:     
Many investment projects have the following characteristics: (i) spending decisions and cash outlays occur sequentially over time, (ii) there is a maximum rate at which outlays and construction can proceed -- it takes "time to build," and (iii) the project yields no cash return until it is actually completed. Furthermore, the pattern of investment outlays is usually flexible,and can be adjusted as new information arrives. For such projects traditional discounted cash flow criteria, which treat the spending pattern as fixed, are inadequate as a guide for project evaluation. This paper develops an explicit model of investment projects with these characteristics, and uses option pricing methods to derive optimal decision rules for investment outlays over the entire construction program. Numerical solutions are used to demonstrate how time to build, opportunity cost, and uncertainty interact in affecting the investment decision. We show that with moderate levels of uncertainty over the future value of the completed project, a simple NPV rule could lead to gross over-investment. Also, we show how the contingent nature of the investment program magnifies the depressive effect of increased uncertainty on investment spending.

Number of Pages in PDF File: 32

working papers series





Download This Paper

Date posted: April 27, 2000  

Suggested Citation

Majd, Saman and Pindyck, Robert S., Time to Build, Option Value, and Investment Decisions (June 1985). NBER Working Paper No. w1654. Available at SSRN: http://ssrn.com/abstract=227193

Contact Information

Saman Majd (Contact Author)
University of Pennsylvania Wharton School
3641 Locust Walk
Philadelphia, PA 19104-6365
United States
Robert S. Pindyck
Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )
50 Memorial Drive, E52-450
Cambridge, MA 02142
United States
617-253-6641 (Phone)
617-258-6855 (Fax)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Feedback to SSRN


Paper statistics
Abstract Views: 2,510
Downloads: 158
Download Rank: 112,513
References:  23
Citations:  74
Footnotes:  21

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo3 in 0.422 seconds