Question

Sometimes a cost must be incurred to obtain an abandonment option. this cost should be incurred if and only if the value of the option exceeds its cost. the value of an abandonment option can be estimated by first calculating the value of the project considering the possibility of abandonment, then subtracting the value of the project if it could not be abandoned. the difference in values is the value of the abandonment option. true or false

Answer 1

Answer: False

An abandonment option is a feature which protects each party’s financial interest in the event an investment fails to earn. It gives a party a right to withdraw from a contract before its maturity.

An abandonment value, on the other hand, is the liquidation value of the asset and can be calculated by subtracting the net present value of the investment from the initial value. If it is negative, then an abandonment option is exercised.