Sincethisisgreaterthanthenegativenetpresentvalueofthe
investment,Airbusshouldenterintothisjointventure.Lear,
however,needstobeabletogenerateapositivenetpresent
valueofatleast$40.09milliontocompensateforgivingup
this option.
17
Implications for Valuation
Just as the option to abandon has value for individual
projects,itcanaffectthevaluesoffirmsthathavebuiltthe
flexibilitytoabandonintotheirinvestmentchoices.Consider
asimpleexampleoftwofirms thatlook exactlyalikeona
DCFbasis—thesameexpectedcash flows,similar costsof
capital,equivalentreturnsoncapital,andthesameexpected
growthrates.Wewouldattachthesamevaluetobothfirms
usingDCFmodels.However,assumethatthefirstfirm(firm
A) has systematically built escape clauses into its big
investments—it uses short-term rather than long-term
contracts, has no long-term union agreements, and leases
ratherthanbuysassets—whereasthesecondfirm(firmB)has
not taken the same steps. Our analysis of the option to
abandon would suggest a higher value for firm A.
Theoptiontoabandonmayalsoprovideusefulinsightinto
thequality ofrevenuegrowthatfirms. Afirmthatcoaxes
customerstobuyitsproductsonmulti-yearcontractswiththe
promisethattheycanbackoutatlittleornocostintheevent
of a recession maypost high growthin revenues,but we
shoulddiscountitsvaluefortheoptionstoabandonthatithas
given its customers.