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Valuation Of A Biotech Company: A Real Options Approach

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Author Info

  • Angel Leon

    ()

  • Diego Piñeiro

    (CEMFI, Centro de Estudios Monetarios y Financieros)

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    Abstract

    The aim of this paper consists of valuating a real biotechnology firm that is based on a portfolio of several drug development projects at different phases. They are patentprotected R&D projects and their values are obtained by implementing an extension of the real options approach in Schwartz (2004). To be precise, the life cycle of the drug is modeled by considering an alternative and more realistic behavior for the evolution of the FCF, different from the standard Geometric Brownian motion, once the peak sales is reached till the patent expiration, we will also allow for the possibility of the generic entrance once the patent expires. Different expected costs to completion are considered here, that is one equation to each compound; a different probability of catastrophic event depending on the phase and so on. It is shown that the abandonment value is higher for those compounds being in preclinical testing than those in clinical trials.

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    Bibliographic Info

    Paper provided by CEMFI in its series Working Papers with number wp2004_0420.

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    Date of creation: Nov 2004
    Date of revision:
    Handle: RePEc:cmf:wpaper:wp2004_0420

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    Related research

    Keywords: Patent; R&D phase; drug; real options; investment cost; free cash flow; generics; life cycle; Monte Carlo simulation.;

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    References

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    1. Hsu, Jason C. & Schwartz, Eduardo S., 2003. "A Model of R&D Valuation and the Design of Research Incentives," University of California at Los Angeles, Anderson Graduate School of Management qt28j7c9r4, Anderson Graduate School of Management, UCLA.
    2. DiMasi, Joseph A. & Hansen, Ronald W. & Grabowski, Henry G., 2003. "The price of innovation: new estimates of drug development costs," Journal of Health Economics, Elsevier, vol. 22(2), pages 151-185, March.
    3. Jason C. Hsu & Eduardo S. Schwartz, 2003. "A Model of R&D Valuation and the Design of Research Incentives," NBER Working Papers 10041, National Bureau of Economic Research, Inc.
    4. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 113-47.
    5. Pindyck, Robert S., 1993. "Investments of uncertain cost," Journal of Financial Economics, Elsevier, vol. 34(1), pages 53-76, August.
    6. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," University of California at Los Angeles, Anderson Graduate School of Management qt43n1k4jb, Anderson Graduate School of Management, UCLA.
    7. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-57, April.
    8. Eduardo S. Schwartz, 2004. "Patents and R&D as Real Options," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 33(1), pages 23-54, 02.
    9. Grabowski, Henry, 2002. "Patents and New Product Development in the Pharmaceutical and Biotechnology Industries," Working Papers 02-25, Duke University, Department of Economics.
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