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Several option-pricing methods can be used for a real options valuation. However, thecomplexity of real world projects makes some of these models not flexible enough toconsider all its features.Binomial trees valuation method appears to be one of the more flexible option pricingmodels and probably a more suitable model for valuing investment with highuncertainty, like R&D projects, comparing to options pricing models likeBlack-Scholes valuation model.The main objective of this paper is to critically review the use of the binomial treesvaluation method for valuing R&D projects in Pharmaceuticals companies. The paperis going to explore the question that whether the real options valuation method canprovide an adequate valuation approach to R&D investment, in the context ofpharmaceutical companies; and whether the binomial trees approach is capable forvaluing investments with high uncertainty like pharmaceutical R&D? A case studymethodology is used to address the above-mentioned questions.In chapter 2, a review of the literature is presented, which start with the definition andtypes of real options, the advantages of real option valuation approach over traditionalvaluation method, followed by the fundamentals of option pricing model, includingfive variables that determines the value of an option, option pricing models andrisk-neutral valuation.Chapter 3 focus on the application of real options valuation method to R&D projectsin pharmaceutical companies. It starts with the review of typical drug developmentprocess, and followed by the analogies of valuation model to real options of R&Dprojects in pharmaceutical companies. The analogies of the five variables thatdetermine the value of an option to real R&D options are discussed in detail.Page | 2
Then, in Chapter 4, the case study is introduced. It is a case that a few overseasuniversities have referred to when introducing the concept of net present value.Chapter 5 presents the valuation of real options realized in the case by using thebinomial trees.Finally in Chapter 6, conclusion is presented together with the limitations.Page | 3
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: Chapter One— IntroductionAs one o
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 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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