Abandonment Value – Definition

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Abandonment Value Definition

An abandonment value refers to the cash value earned on a project after it has been abandoned or discontinued. A project or an asset can be abandoned (liquidated or sold) if its net present value of expected cash flow is lower than the amount received for salvage. Hence, the value of the asset after it has been sold or liquidated is its abandonment value.

Quite a number of factors determine the abandonment value that could be attributed to a project after it has been liquidated or sold. For instance, liquidity, fair value appraisals, supply and demand factors can affect abandonment value.

A Little More on What is Abandonment Value

The cash value or its equivalent that an asset yields after it is discontinued or abandoned refers to abandonment value. Certified appraisers often conduct periodic appraisals of assets in an investment market, this is to determine the profitability or loss attributed to the assets. If an asset is profitable, there is no need to abandon it, if otherwise, it can be sold or liquidated. When assets are liquidated, they are returned to the investor in cash value or its equivalent, this is the abandonment value. When the executives of a company perceive that an asset will not be profitable, they lack the desire to maintain it. In a situation like this, the asset will be sold at distress or at a liquidation price, the amount realized from the sale or liquidation is the abandonment value.

Reference for “Abandonment Value”

Academic research on “Abandonment Value”

Abandonment value and capital budgeting, Robichek, A. A., & Van Horne, J. C. (1967). The Journal of Finance, 22(4), 577-589. This article discusses the relevance of abandonment value in a project life and the capital budgeting process. According to the author, a lot of literature has neglected the possibility of future abandonment in regard to investment proposals appraisal. Projects are always analyzed as though the firms were committed to the project throughout the life cycle. However, the author notes that many projects have significant value throughout their economic life, a factor that ought to be considered in the process of capital budgeting. The article, therefore examines the important of abandonment value, and analyzes how it affects the expected return and risk of a project. In addition, it proposes a framework that takes into account the seldom-considered dimension of project value.

Abandonment value and capital budgeting: Comment, Dyl, E. A., & Long, H. W. (1969). The Journal of Finance, 24(1), 88-95. This note constitutes comments provided by experts on the concept of abandonment value and budgeting. Edward Dyl and Hugh Long, for instance, pay attention on the fact that there is possibility of future project abandonment. The professors have demonstrated that in cases were projects have significant abandonment values, the values should be considered in the capital budgeting process. However, they propose key modifications that must be considered in such abandonment. The note shows that for some cash flow patterns and abandonment values, the abandonment decision rule is sup-optimal. Also, the note proposes an alternative rule that offer optimal results.

Asset growth, abandonment value and the replacement decision of like-for-like capital assets, Gaumnitz, J. E., & Emery, D. R. (1980). Journal of Financial and Quantitative Analysis, 15(2), 407-419. This article describes the key concepts of project management including asset growth, abandonment value, and replacement decisions surrounding a project. The rapid technological advancement witnessed over the years has resulted in the quicker obsolescence and shorter life cycle of projects. According to the authors, once an investment is undertaken, many corporations abandon the project when it suddenly ceased to function, citing that the project is no longer profitable. The author adds that many literatures have demonstrated that a project can be abandoned even before these terminal conditions are experienced. The article cite the work of Robicheck and Von Home who had suggested that in certain instances, projects are abandoned even when they are expected to generate positive cash flows in the following years.

Abandonment value and project life, Myers, S. C., & Majd, S. (2001). Cambridge, 295-312. This article explores the role of abandonment value on the life cycle of a project. The authors first describe the abandonment decision rule stating the key assumptions which include: existence of a meaningful cost-of-capital rate, no capital rationing, all projects possess similar degree of risk, and the existence of meaningful unique internal rate of return. As proposed by Robichek and Van Horne, the abandonment decision rule requires that a project is abandoned when its abandonment value exceeds the net-present value of the subsequent expected future cash flows which are discounted at the rate of cost-of-capital.

A note on abandonment value and capital budgeting, Schwab, B., & Lusztig, P. (1970). Journal of Financial and Quantitative Analysis, 5(3), 377-379. This note discusses the stance of Professors Robichek and Van Horne on the concept of abandonment value. According to the two, the abandonment value model recommends that instead of abandoning a project in the earliest time, all possible cases of abandonment over the asset life should be analyzed. In this regard, the authors recommend the need to select the highest net present value of an asset over abandonment possibilities. This should apply in all projects regardless of the degree of risk or capital rationing.

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