Valuation of an R&D project with three types of uncertainty

Michi Nishihara ()
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Michi Nishihara: Graduate School of Economics, Osaka University

No 17-15, Discussion Papers in Economics and Business from Osaka University, Graduate School of Economics

Abstract: This paper develops an R&D decision-making model in the real options framework. The model is generic enough to capture three types of uncertainty in an R&D project, namely, uncertainty of research duration and costs, market value of technology, and a competitor fs technology development. I derive analytical solutions, which help practitioners and researchers to evaluate various cases of R&D investment. Further, by analyzing the model with a wide range of parameter values, I reveal the following effects of the three types of uncertainty on R&D investment: Higher uncertainty of research duration and costs, unlike market value uncertainty, speeds up investment, especially combined with a higher risk of competition. The investment timing can be U-shaped in the strength of competition because of the trade-off between the preemptive investment effect and the decreased project value effect. These results can account for empirical findings about the uncertainty-investment relation in industries with high R&D intensity and severe competition.

Keywords: Capital budgeting; Decision analysis; Risk; R&D; Real options (search for similar items in EconPapers)
JEL-codes: G31 G33 (search for similar items in EconPapers)
Pages: 24 pages
Date: 2017-06
New Economics Papers: this item is included in nep-cfn, nep-ino and nep-ppm
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