Wednesday, June 23, 2010


Investment Timing and Duration

A firm evaluates a number of investment projects every year. In the absence of a capital constraint, it will undertake all those projects, which have positive net present values (NPVs) and reject those, which have negative net present values (NPVs). Further analysis may, however, indicate that some of the profitable projects may be more valuable (that is, they may have higher NPVs) if undertake in the future. If may also be related that some of the unprofitable projects may yield positive NPVs if they are accepted later on. These categories of investment projects may have different degrees of postponability; some of them may be postponed at the most to one or two periods, while a few may be undertaken any time in future. Those projects, while are postponable, involve two mutually exclusive alternatives: undertake investment now, or later. The firm should determine the optimum timing of investment.

The timing of investment may be a critical factor in case of those investment projects, while occur once in a while and those, while are of strategic importance to the firm. Such projects cannot be deferred for long. Postponability also creates uncertainty. For example, the net present value (NPV) analysis may show that a firm should introduce a new product next year. The firm may still decide to introduce the product this year for two reasons: The firm may have a corporate strategy of remaining market leader in introducing new products. If it anticipates that its competitors will introduce the product this year if it does not, it may come up with the product this year to remain the market leader. Also for the reason of unanticipated competition from unknown quarters the firm may decide to introduce the product now.

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