A Study On Decision Of Two-stage R&D Investment Based On Real Options

It is essential for firms to do research and development which ensures the firm obtaining and keeping competition advantage. Therefore, the R&D project's evaluation is very important. Then how to make Research and Development (R&D) decision under uncertainty is a very essential problem in the practice and theory of management. Usually, the evaluation of project has no restrictions on enterprise's capacity, that isn't true in reality, because the enterprise may have many factors, such as capital, raw materials, production capacity, and so on. Taking into account the possibility of Capital constrain and Price competition in commercialization stage, in this paper we introduce Real Options and Dynamic programming to analyze two two-period R&D project investment models which based on the uncertainty of market demanding conditions.In the first model, we assume the capital of the enterprise is limited. The input of the capital in R&D stage not only has effects on the probability of success of R&D, but also has effects on the marginal cost of new production and the production capacity of the enterprise. To achieve the maximum value of the project, the firm must distribute its capital rationally between the R&D stage and commercialization stage. The optimal investment strategy was given in this paper, and through the numerical analysis we found: when the more demand of the product market, the more Input of capital in the R&D stage; and as the volatility of demand of production market grows, the value of the project and Input of capital in the R&D stage both will increase.In the second model, we introduce the price competition, which belongs to Industrial Organization Theory, into R&D project. After the success of research and development, the investor gets an option accessing to commercialization stage, in which the yield of the enterprise is limited. Because of the access to every stage is flexible, there exists real options. Through real options logical reasoning, this paper made the decision of what time the follower enters into R&D stage and commercialization stage. At last we give an arithmetical example.