TY  - JOUR
AU  - Majd,Saman
AU  - Pindyck,Robert S.
TI  - Time to Build, Option Value, and Investment Decisions
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 1654
PY  - 1987
Y2  - August 1987
UR  - http://www.nber.org/papers/w1654
L1  - http://www.nber.org/papers/w1654.pdf
N1  - Author contact info:
Saman Majd
230 Brookside Road
Darien
CT 06820
USA
Tel: 1 203 655 4987
Fax: 1 203 655 5473
E-Mail: saman@majd.us

Robert S. Pindyck
MIT Sloan School of Management
100 Main Street, E62-522
Cambridge, MA  02142
Tel: 617/253-6641
Fax: 617/258-6855
E-Mail: RPINDYCK@MIT.EDU
AB  - 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.
ER  -