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

Chapter Four— Case StudyFor this paper, the methodology of case study will be used. It is a case of apharmaceutical company with acquiring the compound ‗Davanrik‘. For applying thereal options valuation method to this case, binomial trees approach is chosen to valuethis particular compound, as this approach is considered to be more appropriate tovalue Pharmaceutical R&D projects than other option pricing models likeBlack-Schole model. The reason is for the complexity of this particular case and thatbinomial trees approach accounts for both sources of uncertainty (technological andeconomic) and sequential nature of R&D projects. Furthermore, it was identified thatstrategically important information changing the value of discovery projects, arrivesin a discontinuous way. This process is properly approximated by the binomial treesmodel.In this chapter, the case study of Davanrik at Merck & Co. is going to be introduced.It is a case that a few overseas universities have referred to when introducing theconcept of net present value. The following part of this chapter will introduce thewhole case regarding to Davanrik and Merck & Co. Noting that some information ispresented here for the integrity of the case, for example, the license payment androyalty Merck & Co. pays or would pay to LAB Pharmaceuticals. These will beignored when applying the real option valuation method.4.1 IntroductionRich Kender, Vice president of Financial Evaluation & Analysis at Merck, wasworking with his team to decide whether his company should license Davanrik, a newPage | 37