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

More documents

Recommendations

Info

company, they have a high strategic value (Bode-Breuel, 1997).Growth options are a typical feature of R&D-intensive and technology-basedindustries. Investments in research projects are prerequisites for follow-up projectsthat finally lead to a marketable product. Managers sometimes decide to invest in thedevelopment of a product that, when evaluated alone, does not have a high NPV. Byinvesting in an innovative first-generation product, managers expect that theinfrastructure, experience and knowledge gained will create the basis fro developinghigher-quality and lower-cost follow-up products that will also have higher NPVs. Inaddition, unanticipated applications or by-products may emerge, creating additionalvalue.Accepting risk is an important prerequisite for growth based on innovation.Companies that are too risk-averse destroy their innovative potential and potentiallylose their competitive position. The challenge is to build decisions on a systematicanalysis of project proposals, and on the assumed growth options that projects maycreate. Scientific intuition and passion are necessary prerequisites for analyzing thestrategic value of pharmaceutical R&D projects. Scientists, on the basis of theirexperience and knowledge, are able to develop a vision of follow-up opportunitiesthat may result from a project.Nevertheless, scientific brilliance is not enough. In evaluating the value of marketableassets that could ―grow‖ on a project under consideration, marketing expert arecontributing market models by assessing potential market size, market and sales risks,and product price volatility. Analysts are needed to create financial models thatcapture the option value of R&D projects. In the chapters later, it will be discussedhow appropriate models may be designed. Based on such systematic, interdisciplinaryapproach, management will be in a better position to prioritize projects.Page | 10
2.2 Advantages of Real Option Valuation over other valuationmethods2.2.1. Benefits of real options valuation methodAccording to the report by Technopolis Limited (2005), real options valuationapproach can capture the financial value of the R&D portfolio more accurately, as aresult of the realization of the value of flexibility. And the advantages of real optionsvaluation approach can be as follows:Firstly, according to the characteristics of R&D projects, they are contingent decisionsthat depend on the sequential steps in the future. Investing in the next R&D milestonecan be regarded as investing in a call option on the forthcoming milestone. ResearchProject investment can be considered call options on drug development candidates.Also, outlicensing opportunities can be considered put options. The real optionsthinking are very important for management in evaluating investment opportunitieswith respect to projects‘ valuable contingent claims. In the case of R&D projects,these contingent investment decisions create value for a company since the financialloss is limited only to a small portion of project costs. Also, real options thinking helpmanagement in evaluating growth opportunities that are relevant to the research stageof R&D projects.Secondly, according to Trigeorgis (2004), traditional NPV is a simple discounted cashflow model that is used for valuing passive assets, i.e. valuing predetermined cashflow. In contrast, the real options approach is a financial model that adequatelycaptures the value of operating and strategic options. Therefore, using real optionsapproach to asset valuation is regarded as strategic NPV, which is equal to traditionalNPV plus strategic value (Trigeorgis, 2004). In the case of R&D projects andportfolios, the real options approach to appraisal can be used for managing financialimpact in a way that unfavourable outcomes is minimized, while opportunities tocreate value are exploited.Furthermore, the value of managerial flexibility andPage | 11
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 and 14: project, to get its salvage value,
Page 15: The option to switch:If assets have
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?