A compound option valuation model of R&D-intensive pharmaceutical companies

This paper presents a model for the valuation of R&D in the pharmaceutical sector, both for start-up ventures as well as for big conglomerates. The key understanding is that these projects can be seen as growth options. Traditional valuation techniques as DCF-analysis fail in valuing R&D-intensive pharmaceutical companies because most of their value is embedded in unexercised real options whose future value is uncertain at this moment. If one considers a company as a portfolio of real options, one can value the company based on a compound option model. This estimate will better reflect the fundamental value of the company and cannot be captured by DCF-analysis.