A Hybrid Real Options Approach To R&D Project Valuation

Project evaluation is a hotspot within modern financial research area. Although, traditional approaches have been widely applied to R&D project valuation, they hardly could estimate the intrinsic value objectively. Those methods such as Net Present Value approach are inadequate for many risky projects, thereby they are deemed as limited and often impractical.Given the high risks and uncertainties in R&D project, this paper identifies practical solutions to this problem, i.e., HROV, which combines the best features of decision and options analysis, and HROV, an improved hybrid real option valuating model. The paper describes this new approach and illustrates it with an application to a portfolio of R&D project of a biotic medicine company. The example demonstrates the effectiveness of the new method and indicates that it is a simple and understandable approach. Furthermore, through the recognition of intrinsic and built-in flexibility value, this approach leaded to apparent value increment. When the risks of proposed project were the highest and latter costs were relatively high, the value increment was the greatest.This paper also argues that Black-Scholes Model could only be applied to two-phase R&D investment project, meanwhile, Multi-options model could estimate multi-phase and consecutive R&D investment project. Nevertheless, this time continues model is based upon the hypothesis that managers and decision-makers are able to continuously estimate the future cash flow and the investment amount in each phase. For an industry which contains larger risk compared with the risk of market price, those assumptions in Multi-Options model are impractical. Therefore, discrete binomial tree and the improved model could rightfully reflect the decision-making processes. It is flexible and acceptable by operators, withal, the financial and technological uncertainties are also considered in this method. Yet, the shortage is the ignorance of dividend rate parameter and singleness of project value fluctuation.