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The table below shows the exercise price for each situation at different times. Toillustrate, the exercise prices in year 4 and year 7 are simply the cost to invest for eachof the situations (i.e. Depression only, Weight loss only, and both). But for the optionended in year 2, a common cost of $48.4m should be adjusted. This is done by usingthe weighing of year 4 cost, since the cost of $48.4m is for the purpose of futuredevelopment, in other words, it depends on the weighing of money that Merck & Co.prepare to pay for each of the situations. The reason why only year 4 investment costis relevant is because, the spending of $48.4m is for the purpose to test if thecompound is useful for depression, weight loss, or both, and the subsequent cost foreach situation is seen as the suitable figure to estimate the amount of money thatMerck & Co. is willing to pay for each situation.Table 5.3: Exercise Price of Option A (Year 0-7)Based on these adjustments, the flow chart of the Davanrik R&D process can bePage | 56
ewrite as, noting all the costs (in figure 5.9) are the value adjusted to the real time:Figure 5.9: new flow chart of the Davanrik R&D process (real time value)5.3.2 Valuation of the compound option A using simple valuation methodFor the situation when PV = $1200m, option value V Bd (Depression) = $245.67m needto be add to the last branch of the binomial tree of Option A, which is at the end ofyear 7. At year 7, the value, V, is determined by max [(S-X+V B ), o]. The term(S-X+V B ) represents the situation when the earlier option is exercised, at cost X, but itcan get a value of flexibility. Or say, if and only if the PV together with flexibilityvalue is larger than the cost to continue it, the project can be continued, otherwise, itPage | 57
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 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: these three options, the risk-free
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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