Valuation of patents and R&D projects using real options: a practical implementation

Abstract

The correct valuation of an R&D project is a rather complex process. Aside from the fact that it can take several years to launch a new product after extensive investment, there happens to be a significant abandonment probability at each of the development and exploitation stages. Significant uncertainty is also inherently attached to both development costs and subsequent operational cash flows (be it the case of receiving final approval for commercial purposes).These cash flows need to be estimated with anticipation in order to give a reasonable value for the patent or R&D project. The approach undertaken herein is to consider the patent or R&D project as a complex option on relevant underlying stochastic variables: investment costs and operational cash flows. A model is proposed, programmed and applied to a real case.