DEFINITION of 'Exit Option'

An embedded option within a project that allows the firm abort their operations at little or no cost. An exit option can typically only be exercised after key developments have occurred within the project. Like any other option, this instrument must be purchased at a cost which factors into the capital budgeting decision, but its value is not determined by the price of an underlying asset.

BREAKING DOWN 'Exit Option'

For example, if company XYZ decides to expand their number of operating factories by 10 over five years, an exit option would allow them to abort this operation despite contractual obligations with suppliers and land developers. If, after 2 years, expansion remains a good idea, XYZ can continue to do so. However, if economic conditions have changed, the exit option provides the opportunity to stop further efforts at no cost.

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