Entry and exit decisions with switching regime cash flows

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.

Citation

Hainaut, D. (2012), "Entry and exit decisions with switching regime cash flows", International Journal of Managerial Finance, Vol. 8 No. 1, pp. 58-72. https://doi.org/10.1108/17439131211201031