application of real options analysis for pharmaceutical r d project valuation empirical results from a survey real options analysis was often recommended as an emerging valuation technique for high risk investment projects former inter sectoral surveys have drawn an ambivalent picture of real options usage in general in addition there is a lack of sector specific investigations in the following article the results of an in depth analysis of collected empirical data regarding the application of this new tool in the pharmaceutical sector is presented by capturing the internal view from the pharmaceutical companies themselves and the external view from the health care departments of financial service firms r d stage specific modi of application reasons for reluctance in the employment of real options and their assumed future prospects are elucidated

project options valuation with net present value and decision tree analysis real options analysis roa has been developed to correctly value projects with inherent flexibility including the possibility to abandon defer expand contract or switch to a different project roa allows computing the correct discount rate using the replicating portfolio technique or risk neutral probability method we propose an alternative approach for valuing real options based on the certainty equivalent version of the net present value formula which eliminates the need to identify market priced twin securities in addition our approach can be extended to the case of multinomial trees a useful tool for modeling uncertainty in projects we introduce within decision tree analysis dta a method to derive the different discount rates that prevail at different chance nodes we illustrate the valuation method with an application presented in a scenario approach to capacity planning eppen g d martin r k schrage l e 1989 a scenario approach to capacity planning operations research 37 4 in which the authors state that for the capacity configuration investment decision studied at general motors there is no scientific way to determine the appropriate discount rate based on estimated demand our method allows deriving the scientifically correct discount rates a major result of the analysis is that the discount rates are endogenously derived from the project structure and its behavior in light of prevailing market conditions instead of being exogenously imposed c 2006 elsevier b v all rights reserved

renewable energy policy evaluation using real option model the case of taiwan abstract this study presents a policy benefit evaluation model that integrates cost efficiency curve information on renewable power generation technologies into real options analysis roa methods the proposed model evaluates quantitatively the policy value provided by developing renewable energy re in the face of uncertain fossil fuel prices and re policy related factors the economic intuition underlying the policy making process is elucidated while empirical analysis illustrates the option value embedded in the current development policy in taiwan for wind power in addition to revealing the benefits that re development provides when considering real options analytical results indicate that roa is a highly effective means of quantifying how policy planning uncertainty including managerial flexibility influences re development in addition to assessing the policy value of current re development policy this study also compares policy values in terms of internalized external costs and varying feed in tariff fit simulation results demonstrate that the re development policy with internalized co2 emission costs is appropriate policy planning from sustainability point of view furthermore relationship between varying fit and policy values can be shown quantitatively and appropriate fit level could be determined accordingly

real options analysis and strategic decision making the real options approach is frequently advocated as an approach that offers a positive and radical reassessment of the value of risk and exploration we examine a recent case where merck used the real options approach to justify an investment in an r d project this case is used to highlight some of the problems associated with using real options we note that the assumptions incorporated in most standard option valuation models can conflict with the conclusions reached by strategic analysis as a result users of real options models should understand the quantitative aspects of these models and may often need to create a customized model for each situation the difficulty of developing customized models may explain in part the limited use of the real options approach in strategic analysis

valuation of project portfolios an endogenously discounted method abstract real options analysis roa has been developed to value assets in which managerial flexibilities create significant value the methodology is ideal for the valuation of projects in which frequent adjustments e g investment deferral project scope changes etc are necessary in response to the realization of market and technological uncertainties however roa has no practical application when valuing portfolios of multiple concurrent projects sharing resources as the size of the problem grows exponentially with the number of projects and the length of the time horizon in this paper an extension of roa suitable for the valuation of project portfolios with substantial technological uncertainty e g r d portfolios is proposed the method exploits the distributed decision making strategy encountered in most organizations to decompose the portfolio valuation problem into a decision making sub problem and a set of single project valuation sub problems that can be sequentially solved discrete event simulation is used for the first sub problem while a tailored roa based strategy is used for the set of valuation sub problems a case study from the pharmaceutical industry is used to compare the decision tree analysis dta method and the proposed method

options in the real world lessons learned in evaluating oil and gas investments many firms in the oil and gas business have long used decision analysis techniques to evaluate exploration and development opportunities and have looked at recent development in option pricing theory as potentially offering improvements over the decision analysis approach unfortunately it is difficult to discern the benefits of the options approach from the literature on the topic most of the published examples greatly oversimplify the kinds of projects encountered in practice and comparisons are typically made to traditional discounted cash flow analysis which unlike the option pricing and decision analytic approaches does not explicitly consider the uncertainty in project cash flows in this paper we provide a tutorial introduction to option pricing methods focusing on how they relate to and can be integrated with decision analysis methods and describe some lessons learned in using these methods to evaluate some real oil and gas investments

input and output substitution in higher education abstract this study estimates a multi input multi output model of production in higher education based on data from academic departments from a large public university the results show that there are economies of scale in all dimensions undergraduate and graduate instruction and research of the university s output over the observed range all three types of labor tenured faculty non tenured faculty and graduate assistants are substitutes with the demand for the most skilled category tenured faculty being least elastic

understanding carbon lock in abstract this paper narrative argues that industrial economies have been locked into fossil fuel based energy systems through a process of technological and institutional co evolution driven by path dependent increasing returns to scale it is asserted that this condition termed carbon lock in creates persistent market and policy failures that can inhibit the diffusion of carbon saving technologies despite their apparent environmental and economic advantages the notion of a techno institutional complex is introduced to capture the idea that lock in occurs through combined interactions among technological systems and governing institutions while carbon lock in provides a conceptual basis for understanding macro level barriers to the diffusion of carbon saving technologies it also generates questions for standard economic modeling approaches that abstract away technological and institutional evolution in their elaboration the question of escaping carbon lock in is left for a future paper

an econometric analysis of changes in the cost and production structure of the trucking industry 1953 1982 a cost function is estimated using a time series cross section database for the trucking industry covering the time period from 1953 through 1982 i e after the implementation of the motor carrier act of 1980 which essentially deregulated the industry two conclusions emerge first similarities between early periods of regulation and deregulation are greater than between early and late periods of regulation second a comparison of the regulated and deregulated cost functions indicates that the heaviest burden of regulation was borne by those firms which faced the highest costs copyright 1988 by mit press

persistent heterogeneity of r d intensities within sectors evidence and policy implications abstract do firms in the same sector converge towards the same r d intensities previous research has often assumed this to be true a closer examination using microdata from the eu industrial r d investment scoreboard for the years 2000 2015 shows considerable heterogeneity in r d intensities among firms in the same sector and that this heterogeneity persists over time statistical tests of convergence show that the variation in r d intensities does not decrease over time i e no convergence although firms with an r d intensity below the industry average do seem to catch up with the leaders i e evidence of convergence overall firms in the same industry do not converge to a common r d intensity policy implications are discussed

real options approach based demand forecasting method for a range of products with highly volatile and correlated demand to achieve a competitive edge needed for marketing highly competitive products modern enterprises have actively sought to provide the marketplace with an expansive range of products with high random volatility of demand and correlations between demands of product consequently traditional forecasting methods for separately forecasting demand for these products are likely to yield significant deviations therefore this study develops a real options approach based forecasting model to accurately predict future demand for a given range of products with highly volatile and correlated demand additionally this study also proposes using monte carlo simulation to solve the demand forecasting model the real options approach associated with monte carlo simulation not only deals effectively with random variation involving a particular demand stochastic diffusion process but can handle the correlations in product demand

assessing the impact of wind generation on wholesale prices and generator dispatch in the australian national electricity market abstract growing climate change and energy security concerns are driving major wind energy deployment in electricity industries around the world despite its many advantages growing penetrations of this highly variable and somewhat unpredictable energy source pose new challenges for electricity industry operation one issue receiving growing attention is the so called merit order effect of wind generation in wholesale electricity markets wind has very low operating costs and therefore tends to displace higher cost conventional generation from market dispatch reducing both wholesale prices and conventional plant outputs this paper extends the current literature on this effect through an empirical study employing a range of econometric techniques to quantify the impacts of growing wind penetrations in the australian national electricity market nem the results suggest that wind is having a marked impact on spot market prices and while wind is primarily offsetting higher operating cost gas generation it is now also significantly reducing dispatch of emissions intensive brown coal generation great care needs to be taken in extrapolating these results to longer term implications however the study does propose a methodology for assessing this effect highlights the impacts that wind is already having on nem outcomes and suggests promising directions for future research

higher education costs and scale and scope economies higher education multi product cost functions are estimated for the public and private sectors disaggregated by research comprehensive baccalaureate and associate level institutions the output mix incorporates professional school teaching output in addition to undergraduate and graduate teaching and research outputs scale and scope economies are examined by sector and institutional level also accounting for regional differences ray economies are found throughout the private sector but confined to lower level public institutions research economies are widespread throughout all sector levels economies of scope prevail among private institutions across levels but only among comprehensive and baccalaureate public colleges

a real options perspective on r d portfolio diversification abstract this paper shows that the conditionality of investment decisions in r d has a critical impact on portfolio risk and implies that traditional diversification strategies should be reevaluated when a portfolio is constructed real option theory argues that research projects have conditional or option like risk and return properties and are different from unconditional projects although the risk of a portfolio always depends on the correlation between projects a portfolio of conditional r d projects with real option characteristics has a fundamentally different risk than a portfolio of unconditional projects when conditional r d projects are negatively correlated diversification only slightly reduces portfolio risk when projects are positively correlated however diversification proves more effective than conventional tools predict

valuing risky projects option pricing theory and decision analysis in the academic literature and professional practice there are a number of alternative and apparently competing methods for valuing risky projects in this paper we compare and contrast three different approaches risk adjusted discount rate analysis option pricing analysis and decision analysis focusing on the last two we show that in contrast to some of the claims made in the real options literature when both option pricing and decision analysis methods are correctly applied they must give consistent results we also explore ways in which option pricing and decision analysis methods can be profitably integrated in particular we show how option pricing techniques can be used to simplify decision analysis when some risks can be hedged by trading and conversely how decision analysis techniques can be used to extend option pricing techniques to problems with incomplete securities markets

open innovation a real option to restore value to the biopharmaceutical r d abstract the pharmaceutical landscape has changed and new business models based on alliances are increasingly being adopted in this industry biotechnology advances have pushed this development and pooling complementary resources coming from incumbents and newcomers is a key skill to succeed these are the premises for a quick spread of the open innovation oi paradigm in this industry rd to achieve this goal the authors propose a closed form model that is easy to implement to evaluate the oi initiative for selecting an optimal rd i e licensing in or not and the self financing policy the proposed model can be easily implemented into a spreadsheet and the inputs needed to run it are usually requested to evaluate projects using the most used net present value based methods moreover some parameters of the model allow strategic aspects to be considered for example the nature of the project core non core the impending project phase and the risk sharing opportunity the results of the developed numerical example show that the selected portfolio is well balanced in terms of development stages core non core therapeutic areas and licensing in an inbound open innovation solution is preferred in the case of products at their early stages of development

the merit order effect in the italian power market the impact of solar and wind generation on national wholesale electricity prices abstract italy promoted one of the most generous renewable support schemes worldwide which resulted in a high increase of solar power generation we analyze the italian day ahead wholesale electricity market finding empirical evidence of the merit order effect over the period 2005 2013 an increase of 1 gwh in the hourly average of daily production from solar and wind sources has on average reduced wholesale electricity prices by respectively 2 3 mwh and 4 2 mwh and has amplified their volatility the impact on prices has decreased over time in correspondence with the increase in solar and wind electricity production we estimate that over the period 2009 2013 solar production has generated higher monetary savings than wind production mainly because the former is more prominent than the latter however in the solar case monetary savings are not sufficient to compensate the cost of the related supporting schemes which are entirely internalized within end user tariffs causing a reduction of the consumer surplus while the opposite occurs in the case of wind

multiple output production and pricing in electric utilities empirical studies of the electric utility industry have generally focused on one of several issues such as the presence or absence of regulation induced input mix distortions the rules used to select regulated prices whether electricity is one output or several or the naturalness of the electric utility monopoly this paper contributes a method which permits simultaneous estimation of demand elasticities pricing rule parameters and marginal rates of transformation within one econometric model since firms make input and output decisions given the demand and regulatory conditions facing them the marginal rates of substitution and transformation are dependent on the demand elasticities of each consumer class and the prices permitted by regulators its purposes are two first i examine the appropriateness of a multiple output model of production is electricity one output or are the products sold to different consumers distinct outputs most but not all previous studies treat electricity as a homogeneous product 2 while this assumption may be justified for studies which deal strictly with generation of electricity joskow and schmalensee 27 54 5 observe3 that

solar feed in tariffs and the merit order effect a study of the german electricity market abstract this study investigates the merit order effect moe of the recent years implementation of solar power in germany market clearing electricity prices and production levels are compared for the years 2009 2011 and a model for the relationship between the electricity price and price sensitive electricity production is developed and applied to predict electricity prices in germany from july 2010 to july 2011 with and without solar electricity generation seg the results show that the seg has caused a 7 reduction in average electricity prices for this period the average daily maximum price and daily price variation are also found to decrease by 13 and 23 respectively when taking the moe into account the net consumer s cost of the solar feed in tariff fit system is found to be 23 less than the charge listed in the electricity bill the german fit policy for solar power has been subject to considerable public debate and a common argument brought up in disfavor of the system is the high cost for the consumers in this study we demonstrate the importance of including the moe when evaluating the total costs and benefits of the fit policy mechanism

evaluating pharmaceutical r d under technical and economic uncertainty this study sets up a compound option approach for evaluating pharmaceutical r d investment projects in the presence of technical and economic uncertainties technical uncertainty is modeled as a poisson jump that allows for failure and thus abandonment of the drug development economic uncertainty is modeled as a standard diffusion process which incorporates both up and downward shocks practical application of this method is emphasized through a case analysis we show that both uncertainties have a positive impact on the r d option value moreover from the sensitivity analysis we find that the sensitivity of the option with respect to economic uncertainty and market introduction cost decreases when technical uncertainty increases

real options valuation for a biotechnology company many companies in the biotechnology industry have significant valuations despite having no product revenue because their products are in early stages of development in the past 10 15 years investors have bid up the stock prices of companies showing promise of developing a blockbuster drug we explain the decision tree method and binomial lattice method which adds a growth option and use them to value a biotechnology company agouron pharmaceuticals as the sum of the values of its drug development projects the growth option was added because the development of an initial new molecular entity nme is similar to purchasing a call option on the value of a subsequent nme we compare our computed values of agouron with actual market values at selected points in time during the development of agouron s viracept a drug used to treat hiv positive patients

uncertainty and stepwise investment we analyze the optimal investment strategy of a firm that can complete a project either in one stage at a single freely chosen time point or in incremental steps at distinct time points the presence of economies of scale gives rise to the following trade off lumpy investment has a lower total cost but stepwise investment gives more flexibility by letting the firm choose the timing individually for each stage our main question is how uncertainty in market development affects this trade off the answer is unambiguous and in contrast with a conventional real options intuition higher uncertainty makes the single stage investment more attractive relative to the more flexible stepwise investment strategy

returns to r d on new drug introductions in the 1980s abstract this study finds that the mean irr for 1980 1984 u s new drug introductions is 11 1 and the mean npv is 22 million 1990 dollars the distribution of returns is highly skewed the results are robust to plausible changes in the baseline assumptions our work is also compared with a 1993 study by the ota despite some important differences in assumptions both studies imply that returns for the average nce are within one percentage point of the industry s cost of capital this is much less than what is typically observed in analyses based on accounting data

technical note equivalence of different profitability criteria with the net present value abstract net present value has long been regarded in academic circles as the best criterion for project appraisal however several alternative complementary methods remain popular with practitioners this paper demonstrates that if properly applied several of these standard criteria such as net final value internal rate of return benefit cost ratio profitability index equivalent annuity discounted payback period and average payback period lead to the same investment decision as net present value moreover the paper proves that when choosing between two mutually exclusive projects the application of these criteria to the difference project provides the same ranking as net present value therefore although net present value is regarded as a superior investment criterion any of these popular criteria properly applied serve as well

u s climate policy and the regional economics of electricity generation abstract we examine the interaction between price competition and policy in four iso markets by modeling the economic dispatch of generation technologies and the evolution of generation resources over a fifteen year period beginning in 2016 using a representative range of forward prices for natural gas and other generator costs we model three potential pathways for federal policy 1 the status quo which assumes no new federal initiatives through 2031 2 moderate and aggressive national or regional rpss and 3 carbon taxes that vary in timing and amount the model assesses the impact of these policies on competition between electricity generators using a range of output variables including the cost of electricity emissions of carbon dioxide co2 retirement and construction trends for generation resources and dispatch rates of generation technologies we analyze conditions in four regional electricity markets with distinct starting generation portfolios demand profiles that differ seasonally and diurnally wind and solar resources and fuel costs our results provide new insights into the competitive barrier that low gas prices represent for renewables the superior efficacy of carbon taxes even at low rates over rpss and the singular competitive advantage renewables enjoy by virtue of having near zero marginal costs