R&D impact on a company value: application of real options in pharmaceutical industry

Abstract

Goal: to develop an approach to the solution of the complex multi-stage problem, where the high degree of uncertainty is typical for every phase of the R&D project. Objectives: 1.To analyze the existing models of real option valuation applicable for pharmaceutical industry; 2.To model the theoretical R&D project, which is going to be valued; 3.To apply the basic real option model to value the managerial flexibility, provided by the multi-stage option in the modeled project; 4.To analyze possible rooms for improvement and extension in the basic model; 5.To formalize the extended real option valuation model; 6.To value the multi-stage option by applying the extended model. Main results: The results of real options valuation show that both Decision Tree and Binominal Lattice methods provide higher estimation of the R&D project value in comparison to the traditional NPV method. It was concluded that the real options technique indeed can capture the greater portion of the project value. In its turn, the inclusion of the competition issue into the project modeling allows to better reflect the real-life business situation and to provide managers with a valuable insight into the strategic decision-making.