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In financial terms, an abandonment option can be considered as a put option on aproject‘s current value (however, when a project fails, there is usually not salvagevalue, and the underlying asset is worthless. In this case, the put option is alsoworthless).The option to defer (wait):It is the right to postpone an investment in order to benefit from the resolution ofuncertainty. Even when a project has a positive net present value (NPV) which wouldsuggest an im m ediate ‗go‘ decisio n, it m ay create m ore value to w ait and invest inactivities that provide critical information before going ahead with the project.In the pharmaceutical industry, R&D management is generally focused on completingprojects quickly in order to exploit patent protection in the best possible way(Bode-Greuel, 1997). However, this may not always have priority in the presence ofuncertainty. Even if the expected NPV of a project is positive, it is not necessarily thebest decision to proceed immediately with the next investment. It may create value towait for more information when risk can be reduced, either by waiting to see whetherexternal conditions develop favorably, or by undertaking studies that generate criticalinformation.However, in the pharmaceutical industry, waiting passively is only appropriate whenexternal factors (factors that cannot be influenced by the company), such ascommercial or health political risks, are the source of the risk (Bode-Breuel, 1997).Uncertainties related to R&D are usually best resolved by actively generating thecritical information. If a company was to wait passively for pharmacological ortechnical risks to be resolved by external research institutes or competitors, it wouldloose the opportunity of patent protection and would thus weaken its competitionposition.Page | 8
The option to switch:If assets have more than one application, the option to switch among the possibleapplications will support flexibility and will thereby create value.The option to improve:This type of real option is suggested by Huchzermeier and Loch (1998) as a specialtype of R&D, rather than a type according to common classification of real options.This option occurs where management has the opportunity of taking corrective actionduring the course of a project. For example, the project target profile that outlines thegoals of a project with respect to the desired product properties can be adapted tochanging market conditions.Furthermore, management can adapt the clinical development plan to changedregulatory guidelines. Clinical development can be redefined to accentuate acom pound‘s efficacy profile based on information obtained in previous clinicalstudies (Bode-Breuel, 1997). Thus, the option to improve is relevant for assets that arecharacterized by significant technical risks whose resolution strongly determines themarket value of the asset.The option to improve is an additional source of value, because it helps to exploit theupside potential of uncertainty. The flexibility to adapt development plans on the basisof learning creates value by revealing the best possible product profile. When projectsare re-evaluated after achieving the next milestone, managers may not only considerto continue as planned, or cancel the project when results prove unfavourable.Strategic or growth options:These are opportunities arising in the future by undertaking projects, but are notconstituent of the initial project. Since they pave the way for future growth of thePage | 9
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 12: and we will have the right to take
Page 13: project, to get its salvage value,
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
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