The option to abandon a project inexpensively is likely to have more value when the project:
A) incurs high fixed costs of production.
B) incurs high variable costs of production.
C) generates a positive NPV.
D)has a low degree of operating leverage.

Question

Quizplus · Accepted Answer

When a project incurs high fixed costs of production, the option to abandon the project inexpensively becomes more attractive as it can prevent significant losses incurred by continuing with the project. High variable costs of production can typically be avoided by halting production, so the option to abandon the project inexpensively may be less valuable under these circumstances. A project with a positive NPV may not have the same need for an abandonment option as it is assumed to generate positive returns. The degree of operating leverage is not directly related to the value of an abandonment option.

The Option to Abandon a Project Inexpensively Is Likely to Have