The real options approach to valuation - Haskayne School of Business

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Analysis of R&D projects is a very difficult investment problem • Takes a long *me to complete • Uncertainty about costs of development and *me to comple*on • High probability of failure (for technical or economic reasons) • Drug requires approval by the FDA • Uncertainty about level and dura*on of future cash flows • Abandonment op*on is very valuable
TuVs Center for the Study of Drug Development (December 2001) • Average development *me for new drugs: 12 years • Average total drug research costs (millions) Out-‐of-‐pocket expenses: Including cost of capital (11%): $802 – Calculated at *me of marke*ng of drug $403 – Includes cost of failed drugs (20% success) • More recent figures go up to $4 billion per drug • Yearly US expenditures in prescrip*on drugs :$308 billion (2010)
Page 1 and 2:
The Real Op*ons Approach to Va
Page 3 and 4:
Outline of Talk • Basic ideas
Page 6 and 7:
Using Real Op*ons • Uncertainty
Page 8 and 9:
Investment Projects as Op*ons 3.
Page 10 and 11: Risk Neutral Valua*on • Lets f
Page 12 and 13: Certainty Equivalent Approach NPV
Page 14 and 15: Tradi*onal vs. CE Valua*on Tradi
Page 16 and 17: • If markets are complete (al
Page 19 and 20: Using the Risk Neutral Framewor
Page 21 and 22: True and risk neutral stochas*c
Page 23 and 24: Real Op*ons Valua*on (3) • Nee
Page 25 and 26: Solu*on Procedures
Page 27 and 28: Solu*on Methods (2) • Par*al d
Page 29 and 30: Valuing American Op*ons by Simu
Page 31 and 32: Valuing American Op*ons by Simu
Page 36 and 37: Three Factor Model: Actual (Cort
Page 38 and 39: 30.00Oil Futures 01/08/99Three-Fact
Page 40 and 41: What to do for longer maturi*e
Page 43: NYMEX crude-‐oil futures and
Page 47 and 48: Procedure • We factor analyze
Page 50 and 51: Two Vola*lity Factors (SV2)
Page 52 and 53: Expropria*on Op*on • We value
Page 54 and 55: Assump*ons • We abstract from
Page 56 and 57: Main Results • For a given co
Page 58 and 59: R&D Investments • The pharmaceu
Page 62 and 63: Research Spending Per New Drug Comp
Page 64 and 65: Mediva*on, Pfizer end work on A
Page 66 and 67: R&D Valua*on 1. Evalua*on of Res
Page 68 and 69: Real Op*ons Approach • Treat t
Page 70 and 71: Patent-protected R&D ProjectInvest
Page 72 and 73: Cash Flow Uncertainty Cash flow
Page 74 and 75: Stochas*c process for the (true
Page 78 and 79: Figure 4:Critical Values for Invest
Page 82 and 83: Compe**on in R&D projects • Co
Page 84 and 85: Current Literature on “Encourag
Page 86 and 87: What’s new in this paper? •
Page 88 and 89: Contract Specifics • Developer
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The real options approach to valuation - Haskayne School of Business

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