Valuation of R&D Investment Opportunities with the Threat of Competitors Entry in Real Option Analysis

Giovanni Villani ()

Quaderni DSEMS from Dipartimento di Scienze Economiche, Matematiche e Statistiche, Universita' di Foggia

Abstract: This paper provides a real option methodology for evaluating R&D investment opportunities assuming that potential competitors can en- ter in the market. As it is well known, R&D investments are made often in a phased manner and so each stage creates an opportunity (option) for subsequent investment. Therefore, R&D projects can be consid- ered as ‘Compound Exchange Options' in which investments present uncertainty both in the gross project value and in costs. According to Majd and Pindyck (1987), in a real options context, “div- idends” are the opportunity costs inherent in the decision to defer an investment project and so deferment implies the loss of project's cash flows. Moreover, Trigeorgis (1996) incorporates the preemption effect through the “competitive dividends” which are the cash flows that can be eroded by anticipated competitive arrivals. In this paper we propose to value, using Montecarlo simulation, the R&D investments of a pioneer firm assuming that the Development cost can be spent in two moments: t2 or t3. If the Develpment cost is realized in t2 no firms enters in the market since the rivals' R&D plan is not yet concluded otherwise, if the investment D is delayed at time t3 waiting better market conditions, other rivals can enter in the market and so the opportunity costs (“dividends”) increase.

Keywords: Real options; R&D; Monte Carlo methods; Competitive dividends. (search for similar items in EconPapers)
JEL-codes: C15 D40 G13 O32 (search for similar items in EconPapers)
Pages: 22 pages
Date: 2009-12
New Economics Papers: this item is included in nep-cfn, nep-cse, nep-ino, nep-ppm and nep-tid
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