Structured Approach to R&D Valuation Using Investment Science to Analyze New Ideas

We present a Research & Development case study that illustrates how to model initial decisions vs. down-stream decisions and the uncertainty that characterizes long-term projects of this type. The model recognizes the value of postponing key decisions until their due time along a project’s life. It also incorporates the uncertain outcomes of a Research stage, and the market fluctuations preceding the production and marketing stages. Practitioners will recognize the features of the model as improvements to simply choosing a set of decision inputs and running a Net Present Value analysis to determine which set yields the most valuable cash flow. By incorporating the flexibility of making decisions in due time we provide a model that is closer to the actual thought process followed by Managers and people in charge of funding R&D projects. Although the case study shows only two decisions and two uncertainty sources, the framework can be easily adapted to deal with much more complex cases. The solution process through which a value for the project with all its possible cash flows is computed can also be readily extended.