The Effects of an Uncertain Abandonment Value on the Investment Decision

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Abstract

Using a three-factor stochastic real option model framework, this paper examines the effects of abandonment on the investment decision. Abandonment is classified according to whether the opportunity arises for an active operating asset post-investment, or for holding the project opportunity pre-investment. Separate analytical models are developed for the alternative forms of abandonment optionality. Numerical sensitivity analysis shows that the presence of a post-investment abandonment opportunity makes the investment opportunity appear to be more attractive because of the abandonment option value, but not by a considerable amount. Also, in contrast to the standard real option finding, an abandonment value volatility increase produces a project value threshold fall owing to the increase in the abandonment option value.

Bibliographical metadata

Original languageEnglish
Article numberdoi: 10.1080
Pages (from-to)1083-1106
JournalEuropean Journal of Finance
Volume23
Early online date3 Feb 2016
DOIs
Publication statusPublished - Jan 2017

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