A New Real Options Method for R&D Investment Analysis: Application to CO2 Recycling Technology

31 Pages Posted: 27 Dec 2018

See all articles by Peter Deeney

Peter Deeney

School of Engineering, University College Cork

Mark Cummins

University of Strathclyde

K. Heintz

Dublin City University

M. Pryce

Dublin City University

Date Written: November 29, 2018

Abstract

We propose a new real options analysis method for evaluating R&D investments using a novel Poisson process to simulate the discrete progress typical of R&D breakthroughs. We take explicit account of the technical risk of an R&D project, while the market risk and the effect of learning-by-doing in operational technologies are also explicitly modelled. We present a compound real option structure, where a European real option is used to model the fixed length term typical of early phase research, which is exercisable into an American real option to model later phase R&D. In this later phase, a successful outcome will be acted on immediately to operationalise the technology. We propose a Monte Carlo simulation approach, which models R&D progress in a stylised logistic function or 'S-bend' form, capturing the typically slow rate of R&D progress at the start of the early phase, through to more rapid improvement as the R&D advances, which then slows again as the limitations of the R&D are approached. We demonstrate that this method is applicable for evaluating the R&D investment potential in CO2 recycling technology, where an energy commodity (such as methane) is produced, using appropriate modelling for the price of the energy commodity. The method may be applied widely to R&D technology projects.

Keywords: OR in Research and Development, Real Options, Compound Option Structure, CO2 Recycling Technology

Suggested Citation

Deeney, Peter and Cummins, Mark and Heintz, K. and Pryce, M., A New Real Options Method for R&D Investment Analysis: Application to CO2 Recycling Technology (November 29, 2018). Available at SSRN: https://ssrn.com/abstract=3297541 or http://dx.doi.org/10.2139/ssrn.3297541

Peter Deeney (Contact Author)

School of Engineering, University College Cork ( email )

5 Bloomfield Terrace Western Road
Cork
Ireland
Cork (Fax)

Mark Cummins

University of Strathclyde ( email )

16 Richmond Street
Glasgow 1XQ, Scotland G1 1XQ
United Kingdom

K. Heintz

Dublin City University

Ireland 9
Dublin 9, leinster 9
Ireland

M. Pryce

Dublin City University

Ireland 9
Dublin 9, leinster 9
Ireland

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