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 startup 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.