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Valuation of sequential R&D investment under technological, market, and rival preemption uncertainty

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  • Michi Nishihara

    (Graduate School of Economics, Osaka University)

Abstract

We develop a real options model for evaluating and optimizing an R&D project. The model can capture key features of R&D, including research duration, growth opportunity, debt financing, and uncertainty of technological, demand market, and rival preemption. Nevertheless, it is computationally tractable and thus helps practitioners to evaluate various cases of R&D investment. Further, by analyzing the model with a wide range of parameter values, we unveil the interactions of key R&D features. The effect of duration on investment depends on whether there is a possibility of rival preemption. Higher uncertainty of research duration speeds up project inception in the presence of rival preemption. Higher uncertainty of technological success, combined with a growth opportunity embedded in the R&D project, accelerates investment. Debt financing can greatly decrease time lag between the first stage project and growth project. These results are consistent with the empirical evidence.

Suggested Citation

  • Michi Nishihara, 2014. "Valuation of sequential R&D investment under technological, market, and rival preemption uncertainty," Discussion Papers in Economics and Business 14-13, Osaka University, Graduate School of Economics.
    • Handle: RePEc:osk:wpaper:1413
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    References listed on IDEAS

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    More about this item

    Keywords

    R&D; technological uncertainty; investment lag; real options; compound option.;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • O32 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Management of Technological Innovation and R&D

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