Abandonment option is an option to terminate a project or investment earlier if a disappointing event or performance occurs. Hence, a granting party could rightly withdraw from the contract before the end of the contract.
For example, investor partners with real estate companies to develop a property for 25 years. Investment disbursed amounted to US$300 million. After five years, the investor sees disappointing cash inflows, where the present value of the expected cash flow is estimated at only US$200 million. By having the abandonment option, the investor can leave this project at any time by reselling its shares to the developer.
Where can we find the termination clause?
Abandonment options generally exist in a bilateral agreement. In this agreement, one of the parties involved has the option to terminate the contract without fulfilling its contractual obligations.
This option provides a smaller risk to investors. They can withdraw commitment when conditions worsen.
Such an option is, of course, crucial, especially when investment contracts involve significant funds. Cancellations make it possible to reduce further losses when there is a decrease in value and expected cash flow.
Business contracts often explicitly state options as part of contract terms. In addition to terminating the agreement, the contract also stipulates that no party will be punished if one of them submits an abandonment clause.
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Abandonment options can be found in investment project contracts such as gold mining, cargo ships, heavy equipment, and so on.
Options also often appear in contracts between financial planners and their clients. If the return on investment for funds managed by the planner is below expectations after a certain period, the contract can be terminated.