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

More documents

Recommendations

Info

The main methodology is as follows: firstly, a sampling procedure is used tocalculated the expected payoff from the derivative instrument; next, several likelypath (assuming risk neutral) are simulated for each of the underlying variables; Then,for each path, the payoffs are calculated and discounted back at the risk-free rate ofinterest; and finally, the average of all the paths equals the value of the derivative. ForAmerican style derivatives, however, modifications need to be made.2.3.7 Asset BehaviourMost Option pricing models are founded on a model of asset price movements that isbased on the assumption that tomorrow‘s asset prices cannot be predicted and areunknown. Therefore, suggesting that prices move randomly. Hull (2003) suggests thatseveral stochastic processes can be used to model the bahaviour of the assets whosevalue changers over time in uncertain ways.2.4 Brief summaryIn this chapter, the concept of Real Options valuation approach was explored. Itsusefulness was reviewed by analysing its advantages over the traditional valuationmethods like NPV. The basics of the option pricing theory were reviewed, speciallyaddressing that the risk neutral valuation principle is the perfect framework for optionpricing. Moreover, the option pricing models were presented and their usefulness forreal option valuation was explored including the Monte Carlo SimulationMethodology and basics of asset behaviour. Meanwhile, the concept of combinationof options and compound options were also discussed.In the next chapter, the application of real options valuation method to R&D projectsin pharmaceutical companies is presented.Page | 24
Chapter Three— Apply Real optionsevaluation to R&D projects inpharmaceutical companies3.1 Typical drug development processReal options has been used widely in areas like Research and Development (R&D).And quite a few authors who concern about real options have addressed to theapplication of real options to R&D, including Howell et al. (2001), Paxon (2003),Schwartz (2002), Smith and Trigeorgis. Suggested by Schwartz and Moon (2001), theanalysis of investments in R&D is one of the most difficult problems of investmentunder uncertainty. In R&D projects, which are usually irreversible, there isuncertainty about the investment cost, the future payoffs from the investment, and thepossibility of unforeseen catastrophic events that may terminate the whole effort. Theproblem might seem to be of such complexity as to preclude the possibility ofsystematic ways to deal with it. The analysis of investment projects as complexoptions has been a subject of much research in the past 10 years. It has been applied tovalue mines (Brennan and Schwartz, 1985), oil leases (Paddock, et al., 1988), andprojects with uncertain cost (Pindyck, 1993), among many others.For pharmaceutical companies, the situation may be more complicated. For example,a pharmaceutical company who goes through a FDA drug approval process requiresthree stage of testing, and drug research can be abandoned after each stage.Meanwhile, the FDA approval may have to go through human trials, and the successof the FDA approval depends heavily on the success of human testing, both of whichoccurring at the same time.Page | 25
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 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: t: years to expirationr: annual ris
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?