Briefly explain how abandonment value can be used to help determine project life.
What will be an ideal response?
Most projects' economic lives are not known at the start. In standard DCF capital-budgeting analysis, the life of the project is fixed arbitrarily. For example, cash flows from a new product may last only for a year or less if the product fails in the marketplace. But if the product is successful, then the product or its variations or improvements could be produced for very many years. Real options analysis allows us to arrive at the project's life using financial logic. Here we forecast a range of possible cash flows well beyond the best guess of the project's economic life. Then the value of the project, including its abandonment value, is used, in the best upside scenarios and also in the worst downside scenarios, to analyze the life of the project. This procedure links project life to the performance of the project and does not impose an arbitrary ending date.
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a. True b. False Indicate whether the statement is true or false