Option to abandon
Valuation & CompsThe right to stop or exit a project when it turns out badly, which puts a floor under the downside a committed forecast assumes you have to bear.
Also written: abandonment option, option to suspend, mothballing
The most valuable right in a cyclical business is usually the right to stop. Suspending a mine, shutting a plant, relinquishing an exploration licence, exiting a country: each one replaces an unbounded operating loss with a bounded cost of stopping.
That floor is what the option is worth, and it can be the whole value of an asset. A project whose expected margin averages to nothing across good and bad states is worth nothing only if it is obliged to run in both, which no real operator is.
The exercise cost is the part to get right, because stopping is not free. Care and maintenance, redundancy, contract break costs, and the capital needed to restart later all reduce the option's value, and a restart cost high enough turns a suspension into a permanent closure, which is a different and less valuable right.
It is also the right most often assumed rather than verified. Offtake contracts on take or pay terms, minimum work programmes attached to a licence, lender consents and political constraints on closing a large employer can each remove it entirely, and none of them is visible in the cash flow forecast.
Worked example
A plant loses 20 a year at current prices and would cost 3 a year to hold idle, with a 6 restart cost.
Running it regardless costs 20 a year. Suspending costs 3, so the right to stop is worth 17 a year while prices stay depressed, less the 6 spent when the decision reverses.
If the customer contract is take or pay and obliges delivery, the right does not exist and the 17 is not available at all.