Valuing multistage investment projects in the pharmaceutical industry

Luiz E. Brandão, Gláucia Fernandes and James S. Dyer

European Journal of Operational Research, 2018, vol. 271, issue 2, 720-732

Abstract: Multistage investment projects are subject to several sources of uncertainty, but also present significant embedded flexibilities both during and after the development process. An important characteristic of this class of projects is that as the firm incurs a cost and invests, it learns both about the difficulty of developing and implementing the project and also about market conditions. We develop a real options model where the firm continuously updates its prospects of timely completion and future market conditions. This information can then be used to optimally decide whether further investment is warranted or not, given the expected future revenues of the whole venture. We apply this model to a Research and Development (R&D) project in the pharmaceutical industry and value this investment opportunity as a compound contingent claim where the underlying asset is the value of the completed project, and find that the opportunities to abandon and to expand into related markets and applications once the original product is proven successful have a significant impact on the value of the project as a whole. This article differs from previous work in the field by capturing the potential upsides that may occur during product development through a novel quality model, and their effect on the expansion opportunities during the market phase. We use a simulation approach for the solution and show that for complex real options models, this method can be an effective way to value such projects while providing adequate precision compared to other models in the literature.

Keywords: OR in research and development; Real options; Multistage projects; Valuation (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0377221718304557
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:271:y:2018:i:2:p:720-732

DOI: 10.1016/j.ejor.2018.05.044

Access Statistics for this article

European Journal of Operational Research is currently edited by Roman Slowinski, Jesus Artalejo, Jean-Charles. Billaut, Robert Dyson and Lorenzo Peccati

More articles in European Journal of Operational Research from Elsevier
Bibliographic data for series maintained by Catherine Liu ().