A real option based model for the valuation of patent protected technological innovation projects

Abstract

Decision Tree Analysis and Internal Rate of Return, do not properly consider uncertainty and flexibility, which are crucial for both valuating a project and the related decision-making process. Usually, uncertainty and managerial flexibility have been regarded as a factor that needs to be reduced; nevertheless, Real Option analysis recognizes that both may generate value, since both allow managers to decide on the investment on a project as time unfolds. This research proposes the development of a model and a tool based on real options that supports decision-makers in the valuation process of uncertain projects. The model originally developed by Schwartz and later adapted and modified by Ernst et al. is used as a baseline for the tool. The objective is to develop an easier-to-use-tool for decision-makers to valuate patent protected technological innovation projects which uses fewer variables than the actual model. The expected users are Technology Transfer Offices, which can support the decision-making process of investing on risky projects for its further commercialization. The main results of the model are the probability distribution of the project value and the percentage of times that profit is generated, which are critical factors when deciding to invest in a technological project.