The real options approach to valuation - Haskayne School of Business

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Research Spending Per New Drug Company Ticker Number ofdrugs approved R&D SpendingPer Drug ($Mil) Total R&DSpending1997-2011($Mil) AstraZeneca AZN 5 11,790.93 58,955 GlaxoSmithKline GSK 10 8,170.81 81,708 Sanofi SNY 8 7,909.26 63,274 RocheHolding AG RHHBY 11 7,803.77 85,841 Pfizer Inc. PFE 14 7,727.03 108,178 Johnson &Johnson JNJ 15 5,885.65 88,285 Eli Lilly & Co. LLY 11 4,577.04 50,347 AbbottLaboratories ABT 8 4,496.21 35,970 Merck & Co Inc MRK 16 4,209.99 67,360 Bristol-MyersSquibb Co. BMY 11 4,152.26 45,675 Novartis AG NVS 21 3,983.13 83,646 Amgen Inc. AMGN 9 3,692.14 33,229 Sources: InnoThink Center For Research In Biomedical Innovation; ThomsonReuters Fundamentals via FactSet Research Systems
Pfizer ‘Youth Pill’ Ate Up $71 Million Before It Flopped (WSJ: May 2, 2002) • The experimental drug aimed to reverse the physical decline that comes with aging. • Nearly a decade of research. • Pa*ents taking the frailty drug had gained some muscle mass – but less than 3% more than the placebo group – which also experienced muscle increase. • Drug appeared ineffec*ve.
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 60 and 61: Analysis of R&D projects is a
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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