The option to abandon a project inexpensively is likely to have more value when the product:
A) incurs high fixed costs of production.
B) incurs high variable costs of production.
C) generates a positive NPV.
D) has a steady degree of operating leverage.

Question

Quizplus · Accepted Answer

When a product incurs high fixed costs of production, abandoning the project can help the company avoid further losses. As fixed costs do not vary with the level of production, they represent a sunk cost that cannot be recovered if the project is terminated. In contrast, high variable costs of production indicate that most costs are directly tied to the level of output. In this case, abandoning a project may not be as valuable as reducing production to minimize losses. A positive NPV indicates that the project is expected to generate a return higher than the required rate of return, which makes it desirable to continue. The degree of operating leverage refers to the mix of fixed and variable costs and how they affect the profitability of the product. It is not directly related to the decision to abandon a project.

The Option to Abandon a Project Inexpensively Is Likely to Have