Many Capital Budgeting books, looks like there is no mention about to determine the project duration from the perspective of cash flows. It is so common for people that just because the project has, let’s say 10-year contract, then, the project life is 10 years and people just look at 10-year bond to check the interest.
Fortunately we could grab the idea of Bond duration to measure the duration of corporate project.
By knowing the project duration then we could match it with the bonds duration that we are going to issue. At the end of the day, it is so important to have an asset-liability duration matching, something is so crucial in banking sector. Equity financing is expensive (much expensive that the loan), and it is so easy to think that equity financing is free as it has no obligation to pay the interest, no due date and no incurrence/maintenance covenants. So I always suggest to see the equity financing as the last option to go to get the money for the project financing.
By picking up the bond duration matched with the project duration, we could learn something about the the sensitivity of the project value by looking at the relationship between bond duration and its interest and bond value.
[to be continued]