Use options methodology to value an option to abandon with the data in Figure 13.5. This is a put option where the abandonment leads to a 50 per cent recovery of 500,000.

The total project lasts ten years and an abandonment option exists for the first five years. The volatility is estimated at 20.0 per cent against a risk-free rate of 5.0 per cent. The annualized yield for the d1 calculation is 1/T or 10.0 per cent. The formula for the option value is:

The value of the option can then be compared against the value of abandonment. A sensitivity table will show how the value changes with increased volatility

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A B Exercise inputs D 45678910 Years T 10.0 yrs Risk Free Interest Rate Int 5.00% Volatility PV of Future Cash Flows P Capital Value 10 Salvage % of Capital Value 11 Years Remaining SPE 20.00% PV 1,500,000.00 1,000,000.00 50.00% TR 5.0 yrs Figure 13.5