A Simple Approach for Deciding When to Invest

Abstract

In this paper we derive a straightforward generalization of the net present value rule that correctly predicts when to invest in a class of projects that can be delayed. It is shown that the optimal rule for investing in such projects is to simply multiplying the discount rate of the project by the ratio of the mortgage rate to the riskless rate and then use this new rate as the discount rate in a standard net present value analysis. The mortgage rate is defined to be the rate on a riskless bond that is callable at par at any time. Besides its simplicity, this rule has the added advantage that it does not depend on a maintained assumption on the dynamics of interest rates in the economy.

JEL Classification: G31, E22, G21, G13