Entry and exit decisions with switching regime cash flows

Donatien Hainaut

International Journal of Managerial Finance, 2012, vol. 8, issue 1, 58-72

Abstract: Purpose - The purpose of this paper is to propose a method to plan entry and exit times of a project delivering cash flows influenced by business cycles. In this setting, the profit yield by the project are driven by a geometric Brownian motion whose mean and variance switch between a finite number of regimes. Design/methodology/approach - In the existing literacy, an activity is started or aborted once that the current potential profit jumps over a barrier. Due to operational delays, this investment rule can be inefficient in practice. For this reason, the approach developed in this work relies on the assumption that a manager chooses entry and exit times that maximize on average the expected discounted profits. Findings - In this model, entry and exit times are then solutions of a simple non‐linear system of equations. The author also shows how the parameters ruling the switching regime cash flows associated to a project can be inferred from the stock market quotes of a company, active in the same sector of activities. To illustrate the tractability of the model, the author applies it to a project in the healthcare industry. Originality/value - The model proposed in this paper is tractable for a wide set of investment/disinvestment problems.

Keywords: Project management; Cash flow; Profit; Real option; Switching regime; Optimal entry; Exit times; G3; C6 (search for similar items in EconPapers)
Date: 2012
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Persistent link: https://EconPapers.repec.org/RePEc:eme:ijmfpp:v:8:y:2012:i:1:p:58-72

DOI: 10.1108/17439131211201031

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