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Valuation of a Biotech Company: A Real Options Approach

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Listed:
  • Ángel León
  • Diego Piñeiro

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.

Suggested Citation

  • Ángel León & Diego Piñeiro, 2004. "Valuation of a Biotech Company: A Real Options Approach," Working Papers wp2004_0420, CEMFI.
    • Handle: RePEc:cmf:wpaper:wp2004_0420
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    References listed on IDEAS

    as
    1. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," The Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 113-147.
    2. Nicolas P. B. Bollen, 1999. "Real Options and Product Life Cycles," Management Science, INFORMS, vol. 45(5), pages 670-684, May.
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    7. 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.
    8. Schwartz, Eduardo S. & Zozaya-Gorostiza, Carlos, 2000. "Valuation of Information Technology Investments as Real Options," University of California at Los Angeles, Anderson Graduate School of Management qt4dv270zv, Anderson Graduate School of Management, UCLA.
    9. Grabowski, Henry, 2002. "Patents and New Product Development in the Pharmaceutical and Biotechnology Industries," Working Papers 02-25, Duke University, Department of Economics.
    10. 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.
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