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5.4 Sensitivity Analysis and comparison of two methods5.4.1 Sensitivity AnalysisAs for Option A, the estimation of volatility is relatively rough, the sensitivelyanalysis is preferred to show the relationship between option value and volatility, andthe impact of volatility change to option value. Take the volatility with the range 40%to 70%, three compound options with different underlying asset value are calculated,and final option values are combined according to the corresponding probabilities, asshown in the table below.Table 5.5: Calculation for option value with different volatilityAs uncertainty is higher in pharmaceutical industry than other industries, carefulconsideration should be taken when applying real option valuation models topharmaceutical investment. When the range of volatility (e.g. 40% to 70%) in the realworld situation is incorporated for decision making, the option value is between$86.935 million to $99.99million, and the ENPV is within a range of $100.915Page | 64
$ in millionmillion to $113.97 million, derived from the first valuation method (simpler). Butusing the second method, the value of the option (Value of Option*) is within a rangeof $16.17 million to $35.07 million. And the relationship between option value andvolatility is shown as in the figure below:120.00100.0080.0060.0040.0020.000.00Value ofOptionValue ofOption*0.4 0.45 0.5 0.55 0.6 0.65 0.786.94 88.25 90.45 92.84 95.27 97.66 99.9916.17 19.33 22.51 25.69 28.88 32.01 35.07VolatilityValue of OptionValue of Option*Figure 5.14: Sensitivity Analysis for two valuation methods5.4.2 Comparison of two valuation methods and conclusionThe solution of option value A is derived from two methods. The first one is simpler,without any consideration of two sources of uncertainties, and the second one to valuea compound rainbow option is rather complicated, but with the incorporation of themarket and technical uncertainty (unrelated). And the value of the project is found tobe much larger by using first valuation method. Compared with the traditional NPVmethod, this method generates a value 7 to 8 times the original one. The secondvaluation method, the more accurate one, has increased the NPV from $13.98 millionto $49.05 million, with a $35.07 million option value. This result is quite influencingfor the investment decision concerning further financing, although is constrained byits limitations and therefore accuracy.To value this Davanrik project at Merck & Co., the second valuation method shouldbe used, as it incorporates with two separate and unrelated uncertainties. Valuation byusing the first (three separate binomial trees and combining the value according toPage | 65
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 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: Figure 5.13 Valuation of Compound r
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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