application of real options valuation to r&d investments in ...

More documents

Recommendations

Info

mean that a company is temporarily reducing capacity in a certain business areabecause conditions have developed unfavorably. For example, a company mightdecide to reduce in-house research capacity in neurodegenerative diseases, becausethe results obtained so far have been disappointing in relation to the resources that hadbeen invested. Instead, research is continued at a lower funding level by co-operatingwith universities. However, the company would like to retain the option of expandingin-house activities when promising results emerge from university research.―Know how‖-intensive industries face the challenge that temporarily reducingcapacity does not only mean closing facilities, but also not using their employees‘expertise property. Scientists specialized in neurodegenerative diseases cannot betemporarily assigned other research projects, because acquitting expertise in anotherarea take time. Furthermore, they may become frustrated and leave the company,leading to a drain of expertise. The number of employees working in a productionfacility can be adapted more easily to changing demands, than the number of expertsworking in a certain business area. Expert knowledge and long-term commitment ofexperts to their company are valuable assets that should be traded off against thebenefit of adapting operating scale in R&D.In summary, the option to adapt operating scale is not as readily applicable toR&D-intensive industries as it is to businesses whose profitability predominantlydepends on the optimal adaptation to volatile market prices. Rather, R&D requires along-term strategic orientation in order to build up the required capabilities and attracthigh-level experts. This also applies to small and medium =sized companies, whichoutsource many of their technical operations.The option to abandon:The option to abandon a project provides partial insurance against failure, as once theproject is no longer profitable, the company can exercise this option to abandon thePage | 6
project, to get its salvage value, A , w hich is the value of the project‘s assets if so ld orshifted to a more valuable use. The option to abandon is a put option, and the exerciseprice is the salvage value, A.It is possible that, during development, managers realize that the market for a productdevelops unfavorably. A newly-launched medicine may weaken the competitiveposition of the product in development, or health political decisions may affect theprofitability of the compound such that it no longer deserves priority compared to theother development compounds of the portfolio. In this case, management may decideto cancel development in order to free resources for more promising projectcandidates; alternatively, the project may be out licensed, thereby creating a salvagevalue. Furthermore, there may be project-specific assets, such as technical equipment,that can be sold on the second-hand market. Nevertheless, abandonment should not beexercised lightly; it might lead to an erosion of valuable expertise or organizationalcapabilities that could be applied to forthcoming projects (Bode-Greuel, 1997).The most relevant abandonment option in pharmaceutical R&D is the necessity toterminate a project because the results of R&D activities did not meet management‘sexpectations. A research concept may simply not work out. In development, there aremany critical milestones that need to be achieved, and the majority of projectsentering development have to be abandoned at a certain stage. If failure is the reasonfor abandonment, there is no tangible salvage value. The value of the option is relatedto the fact that further investments are saved. Furthermore, valuable expertise mayhave been obtained, to the benefit of other forthcoming projects.Modeled abandonment options in decision trees enable management to investigate indetail the risk structure of a project, and take actions to increase the value of a project.For example, completing risky studies early rather than late will create value, becausethe chances of abandoning the project before high costs have occurred are increased.Page | 7
Page 1 and 2: APPLICATION OF REAL OPTIONS VALUATI
Page 3 and 4: Table of ContentsAbstract .........
Page 5 and 6: List of TablesTable 5.1: Value of O
Page 7 and 8: Chapter One— IntroductionAs one o
Page 9 and 10: Then, in Chapter 4, the case study
Page 11: and we will have the right to take
Page 15 and 16: The option to switch:If assets have
Page 17 and 18: 2.2 Advantages of Real Option Valua
Page 19 and 20: In the case of pharmaceutical R&D,
Page 21 and 22: delayed in time. Undertaking one pr
Page 23 and 24: Figure 2.2: Advantages and disadvan
Page 25 and 26: smallest possible payoff of zero, w
Page 27 and 28: options applications is the binomia
Page 29 and 30: t: years to expirationr: annual ris
Page 31 and 32: Chapter Three— Apply Real options
Page 33 and 34: on Howell et al (2001).3.1.1 Precli
Page 35 and 36: approved.3.2 real options valuation
Page 37 and 38: Figure 3.3: Comparison of a call op
Page 39 and 40: applying the principals of activity
Page 41 and 42: that has occurred in the past. Depe
Page 43 and 44: Chapter Four— Case StudyFor this
Page 45 and 46: 4.3 DavanrikLAB Pharmaceuticals ori
Page 47 and 48: efficacious for depression only, a
Page 49 and 50: Chapter Five— Case Study Analysis
Page 51 and 52: figure below:Figure 5.3: NPV of Dav
Page 53 and 54: Merck & Co (10%), which gives $2338
Page 55 and 56: approval and other issues. Therefor
Page 57 and 58: of $345m at year 0 (which is $672.3
Page 59 and 60: project turns out to be unprofitabl
Page 61 and 62: these three options, the risk-free
Page 63 and 64:
ewrite as, noting all the costs (in
Page 65 and 66:
Figure 5.10: Valuation of Option A
Page 67 and 68:
Figure 5.12: Valuation of Option A
Page 69 and 70:
Figure 5.13 Valuation of Compound r
Page 71 and 72:
$ in millionmillion to $113.97 mill
Page 73 and 74:
Chapter Six— Limitations and conc
Page 75 and 76:
discovery projects, arrives in a di
Page 77 and 78:
References1. Amram M & Kulatilaka N
Page 79 and 80:
31/08/2006, available at: http://ho
Page 81 and 82:
46. T rigeorgis L . (1995), ―M et
show all

application of real options valuation to r&d investments in ...

Create successful ePaper yourself

Delete template?

Save as template?