2)Investment Timing Options3)Growth Options4)Flexibility Options
1)Abandonment or Shutdown Options
In traditional business format, a project is said to run throughout itslifetime but a firm may have option of ceasing the project anytimeduring its life. This is called abandonment or shutdown options. Thisoption means the right to sell the cash flows over the remainder of theprojects life for some value.When the present value of the remainingcash flows falls below the liquidation value, the asset may be sold.Abandonment is effectively the exercising of a put option. Theseoptions are particularly important for large capital intensive projectssuch as nuclear plants, airlines, and railroads. They are also importantfor projects involving new products where their acceptance in themarket is uncertain.
Suppose your resource management company has a two-year leaseover a small copper deposit and is deciding whether or not to mine thedeposit. At the end of the lease, all rights to the property revert to thegovernment. It is known that the deposit contains eight million poundsof copper. Mining would involve a one-year development phase thatwould cost $1.25 million immediately. The company would then pay allextraction costs to a subcontractor, in advance, at a rate of 85 centsper pound. This amounts to a cash payment of $6.8 million one yearfrom now. Your company would then sell the rights to the copperrecovered (8 million pounds) to a third party at the spot price of copper
IIPM, AhmedabadPage 3