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R&D as an option on market introduction
Author(s) -
Lint Onno,
Pennings Enrico
Publication year - 1998
Publication title -
randd management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.253
H-Index - 102
eISSN - 1467-9310
pISSN - 0033-6807
DOI - 10.1111/1467-9310.00104
Subject(s) - discounted cash flow , valuation (finance) , valuation of options , cash flow , black–scholes model , economics , net present value , value (mathematics) , option value , market value , present value , binary option , financial economics , actuarial science , asian option , microeconomics , finance , computer science , volatility (finance) , machine learning , production (economics) , incentive
Discounted cash flow methods for making R&D investment decisions cannot properly capture the option value in R&D. Since market and technology uncertainties change expectations about the viability of many new products, the value of projects is frequently adjusted during the R&D stages. Capturing the adjustment in expectations has an option value that may significantly differ from the Net Present Value of R&D projects. However, there are no historic time series for estimating the uncertainty of the value of R&D projects. As a result, the standard Black and Scholes model for financial option valuation needs to be adjusted. The aim of this paper is to report the application of a particular option pricing model for setting the budget of R&D projects. The option value of the model captures jumps or business shifts in market or technology conditions. The approach originates from applying current insight into the valuation of R&D projects to the field of multimedia research at Philips Corporate Research. This way, the gap between real option theory and R&D practice is further diminished.