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

Decision Tree Analysis and Internal Rate of Return, do not properly take into account uncertainty and flexibility, which are crucial for both valuating a project and the related decision-making process. Usually, uncertainty has been regarded as a factor that needs to be eliminated; nevertheless, Real Option Analysis (ROA) recognizes that it may generate value. Similarly, managerial flexibility is usually not taken into account; however, it is possible and necessary to valuate it, since it allows managers to decide on the investment, or disinvestment, on a project as time unfolds. Despite the advantages of using ROA, it is still not widely used among decisions-markers. Consequently, the present research proposes the development of a model based on real options that supports decision-makers in the valuation process of uncertain projects. The model originally developed by Schwartz [1] and later adapted and modified by Ernst, Legler and Lichtenthaler [2], is used as a baseline. The objective is to develop a tool (by simplifying the previous models) that can be easily and intuitively used by decision-makers to valuate patent protected technological innovation projects. Accordingly, its main users are expected to be Technology Transfer Offices, which can use it as a tool that supports 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 are generated, which are critical factors when deciding to invest in a project.