Application Of Real Options To R&D Projects Valuation

Real options have been growing in popularity in recent years, it enable companies or managers to value investment projects under uncertainty. The R&D projects have the characteristic of uncertainty, multi-stage and managerial flexibility, therefore real options have been used extensively in R&D projects. In view of the multi-stage character of R&D projects, we will apply two discrete time models and three continuous time models in order to value the compound option.There are mainly two parts in the thesis. In the first part, we present the basic theory of real options, including the concepts, classification and the distinction with financial option. Then we show the character of real option and the limitations of NPV and DTA methods. As our target, we discuss the feasibility of real options application on R&D projects, mainly dwell on the analysis of option factor of R&D projects. In addition to the above, we also introduce various real options model which could be used to value R&D options, and improve the models of binomial and trinomial tree to models with changing volatility. In the second part, taking pharmaceutical project as an example, we price the different stage volatility different R&D project by use of binomial and trinomial tree with volatility. Furthermore, we value R&D project using the Black-Scholes model, Margrabe model and Geske model respectively. We then analyze the differences of these results.Because we apply real options method to R&D project evaluation, and value the different stage volatility different R&D project by using binomial and trinomial tree with changing volatility, we could obtain result more close to reality. This increases the rationality of decision-making in investment.