Project Valuation for the Strategic Management of Research and Development: The Abandonment Option

Abstract

The most widely used technique for evaluating projects is discounted cash flow. However, discounted cash flow analysis fails to consider flexibility. Real options analysis offers an alternative technique that provides value for the inherent managerial flexibility that most R&D projects contain. This paper investigates the abandonment option using computer simulation. There are five variables that determine the value of the abandonment option, and simulations analyze these variables over a wide range of conditions.