Introduction to research & development decision analysis

Résumé du document

A firm optimizes its market value when it successfully implements strategies that generate positive discounted cash flows applied against initial investments with net present value (NPV) greater than zero. One purely economic analysis, which serves as a guidepost to this work, applies a discounted cash flow (DCF) approach using stylised assumptions to estimate that the net present value (NPV) of R&D funding In other words, the authors ( Seddiqui et .al. 2007) go on to demonstrate, the DCF approach is not an appropriate economic analysis under uncertainty.In fact, many organizations evaluate projects by estimating their net present value (NPV). NPV is calculated by projecting expected future cash flows, "discounting" the future cash flows by the cost of capital, and then subtracting the initial investment. Conventional wisdom directs us to undertake projects if NPV is positive, but this does not guarantee funding. Organizations typically consider other factors, which incorporate their ability to fund the initial investment given their capital structure, current operating cash flow positions, strategic considerations and financial expectations (April et al. 2006). In the absence of risks, we use the risk free opportunity cost of capital to discount back the cash flows associated with the strategy. If risks are involved, and the level of uncertainty is presumably known for the cash flows generated by the strategy, given efficient market hypothesis, we will use the corporate weighted average cost of capital to calculate the worth of the strategy.

Extraits

[...] They are under continual pressure to improve capital investment performance. They need technology to help communicate the analysis and clearly identify the reasons for specific investment decisions. They worry that competitors may adopt new and more advanced technology. Capital investment decisions are usually accomplished with traditional analyses that include net present value and mean-variance analysis. Consequently most organizations use similar methods to evaluate and select capital spending options. The decisions of committing limited resources to multiple uses can either strengthen or deteriorate their very financial foundation. [...]

[...] On one end of the spectrum, capital budgeting procedures often employ traditional operations research techniques to guide and support decisions. On the other end, executives admit that selections come down to intuition, combined with seat-of-the-pants “guestimates,” and peppered with squeaky wheel assignments. Typically, however, what is common is to build models that employ pro-forma plans centering on measures of the benefits of the investments returns, payback period, and risk. In a seminal paper in 1952 in the Journal of Finance, Nobel laureate Harry Markowitz laid down the basis for modern portfolio theory. [...]

[...] 2007) go on to demonstrate, the DCF approach is not an appropriate economic analysis under uncertainty. In fact, many organizations evaluate projects by estimating their net present value (NPV). NPV is calculated by projecting expected future cash flows, “discounting” the future cash flows by the cost of capital, and then subtracting the initial investment. Conventional wisdom directs us to undertake projects if NPV is positive, but this does not guarantee funding. Organizations typically consider other factors, which incorporate their ability to fund the initial investment given their capital structure, current operating cash flow positions, strategic considerations and financial expectations (April et al. [...]

[...] C. and Wiser R.H. (2007). Real options valuation of US federal renewable energy research, development , demonstration and deployment” , Energy policy 265-297. Truong, T. (2005). Finding new technology with real options”, Proceeding of 2005 Crystall Ball User Conference. Acknowledgment Foremost I would like to thank centre for operational research and applied statistics, University of Salford for providing me the scientific articles necessary to write the current course. [...]

[...] Traditional valuation techniques for R&D (e.g., decision trees and NPV) may exacerbate the fundamental problems associated with investment analysis and portfolio management, because these techniques rely solely on information that is available at the time of the analysis and cannot accurately value flexibility over time. The limitations of these techniques often go unrecognized by decision-makers, resulting in suboptimal R&D investment decisions. Company which uses an R&D management approach that recognizes three key realities for its core competency: Uncertainties are resolved on a continuous basis as R&D is conducted, competitive conditions change, and market expectations evolve. [...]