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Valuation of R and D Projects Using Options Pricing and Decision Analysis Models

Robert K. Perdue, William J. McAllister, Peter V. King and Bruce G. Berkey
Interfaces
Vol. 29, No. 6 (Nov. - Dec., 1999), pp. 57-74
Published by: INFORMS
Stable URL: http://www.jstor.org/stable/25062542
Page Count: 18
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Valuation of R and D Projects Using Options Pricing and Decision Analysis Models
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Abstract

A combination of options-pricing techniques and decision-analysis tools forms a practical process for evaluating R and D projects in a way that correctly values the impact of decision flexibility and the inevitable technical and commercial uncertainties. The options perspective leads to research-funding and project-selection decisions that can be radically different from those developed using the standard net-present-value financial rule. Decision-analysis tools simplify data acquisition. We applied the process at the Westinghouse Science and Technology Center using 13 embryonic research projects as a pilot test and subsequently applied it to the center's complete portfolio of research projects. Such an approach can be cost-effective for the type of scaled-down and decentralized research efforts that increasingly characterize US industry and can help research managers to optimize the level and composition of their research portfolios.

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