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

Author

Listed:
  • Robert K. Perdue

    (Westinghouse Electric Company, 1340 Beulah Road, Pittsburgh, Pennsylvania 15235-5082)

  • William J. McAllister

    (Siemens Westinghouse Power Corporation, 1310 Beulah Road, Pittsburgh, Pennsylvania 15235)

  • Peter V. King

    (Century Farm Convenience Center, 2100 Highway 86, Piedmont, South Carolina 29673)

  • Bruce G. Berkey

    (Ingersoll Rand, 98100 West Kincey Avenue, Huntersville, North Carolina 28078)

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.

Suggested Citation

  • Robert K. Perdue & William J. McAllister & Peter V. King & Bruce G. Berkey, 1999. "Valuation of R and D Projects Using Options Pricing and Decision Analysis Models," Interfaces, INFORMS, vol. 29(6), pages 57-74, December.
    • Handle: RePEc:inm:orinte:v:29:y:1999:i:6:p:57-74
    DOI: 10.1287/inte.29.6.57
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    References listed on IDEAS

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    1. Donald L. Keefer & Samuel E. Bodily, 1983. "Three-Point Approximations for Continuous Random Variables," Management Science, INFORMS, vol. 29(5), pages 595-609, May.
    2. Merton, Robert C., 1976. "Option pricing when underlying stock returns are discontinuous," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 125-144.
    3. Elizabeth Olmsted Teisberg, 1994. "An Option Valuation Analysis of Investment Choices by a Regulated Firm," Management Science, INFORMS, vol. 40(4), pages 535-548, April.
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    Cited by:

    1. A Morton & D Bird & A Jones & M White, 2011. "Decision conferencing for science prioritisation in the UK public sector: a dual case study," Journal of the Operational Research Society, Palgrave Macmillan;The OR Society, vol. 62(1), pages 50-59, January.
    2. Yeu-Shiang Huang & Li-Chen Liu & Jyh-Wen Ho, 2015. "Decisions on new product development under uncertainties," International Journal of Systems Science, Taylor & Francis Journals, vol. 46(6), pages 1010-1019, April.
    3. Donald L. Keefer & Craig W. Kirkwood & James L. Corner, 2004. "Perspective on Decision Analysis Applications, 1990–2001," Decision Analysis, INFORMS, vol. 1(1), pages 4-22, March.
    4. Ozer, Muammer, 2005. "Factors which influence decision making in new product evaluation," European Journal of Operational Research, Elsevier, vol. 163(3), pages 784-801, June.
    5. Valdivia, Miguel & Galan, Jose Luis & Laffarga, Joaquina & Ramos, Juan-Luis, 2020. "A research and technology valuation model for decision analysis in the environmental and renewable energy sectors," Renewable and Sustainable Energy Reviews, Elsevier, vol. 122(C).
    6. Baker, Erin & Keisler, Jeffrey M., 2011. "Cellulosic biofuels: Expert views on prospects for advancement," Energy, Elsevier, vol. 36(1), pages 595-605.

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