| The most widely used technique for evaluating projects is discounted cash flow. However, discounted cash flow analysis fails to consider flexibility. Real options analysis offers an alternative technique that provides value for the inherent managerial flexibility that most R&D projects contain. The intent of this study is to investigate methods of valuating research and development projects. This consists of the comparison of alternative techniques including a detailed investigation of real options analysis. The investigation compares the relationships of future cash flow, investment costs, interest rates, time, and volatility with the estimated net present value of the project using computer simulations. Such valuation analysis can aid the firm in managing R&D projects for maximum strategic value.; There are four primary management options regarding R&D projects. First, a project may be delayed if future information will decrease the decision risks. Second, projects can be abandoned if their salvage value exceeds the project's future returns. Third, projects may be expanded at a later date if the increased revenue is greater than the expansion cost. Finally, many projects occur in several phases, with each phase dependent on the success of the previous one. Each of these options is explored in detail.; The volatility of the project is the most difficult of all of the variables to forecast, and measure, and the option value is highly dependent on the volatility estimate. Volatility is explored, and various financial products are investigated to determine if they can be used as surrogates for preliminary volatility estimates. |
