Question

In: Finance

How the option to abandon a project is reflected in business valuation?

How the option to abandon a project is reflected in business valuation?

Solutions

Expert Solution

Abandonment option is an option that gives the parties to contract and option of abandoning the contract before the expiry.so abandonment of a project means a project which is less risky nature and it is a project which is adjusted with risk weighted and it should account for abandonment which will provide additional value to the overall project.

The cost of abandonment is to be discounted with the overall value of project and it will provide an additional advantage to the company and it is a real value option.

Valuation of these options can be done through discounting cash flows and net present value method. Real business value of these options are higher than the value of NPV in some cases .

These are a part of benefits on the faces of different business so they will always be providing additional value and such contract will have always have better net present value and acceptability criteria becausebecause they have the cost of abandonment associated with them.


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