Where does the R&D financing come from ?
- Corporate sector → government
* Little amount from academia but put to work significant amount of government funds
What is basic research ?
- Objective : gain more comprehensive knowledge or understanding of subject under study without specific applications in mind
- In industry, defined as research advances scientific knowledge but does not have specific immediate commercial objectives although may be performed in fields of present or potential commercial interest
What is applied research
- Objective : gain knowledge or understanding to meet specific, recognized need
- In industry: includes investigations to discover new scientific knowledge having specific commercial objectives w-r. to products, processes or services
What is the development ?
Systematic use of knowledge directed toward production of useful materials, devices, systems or methods including design and development of prototypes processes
What are the themes of R&D finance ?
- Nonlinearities → simulation
- Decision made over time → Real options
- Multiple decision makers → Game theory
What are the three types of risk the themes of R&D finance give rise to ?
- Technical
- Business
- Competitive
What is the technical risk ?
- Concerns uncertainty in problem development
- idiosycratic risk
- Use simulation to incorporate it
What is the Business risk ?
- Concerns changes in economy conditions
- Systematic risk
- Use real options
What is the competitive risk ?
- Concerns threat posed by competitors
* Use game theory• Internal funds
How can a pharmaceutical finance the development of products ?
- Internal funds
- Public markets
- Strategic alliances/licensing
- VC
What is alliance and licensing ?
Major source of funding for private and small public biopharma companies
What are the most common components of licensing deals ?
- Upfront fees
- Milestone payment
- Royalties
- R&D funding
- Equity investments
What are the limitations to traditional NPV analysis ?
- Static : only one decision to be made
- Assumes project is run at its initial scale throughout its life
- Assumes management has no opportunities to alter project once investment made
What are the multiple decisions to make during the project by managers ?
- Best time to make initial investment
- Scale of project be increased or reduced at some point in the future
- Project abandoned at some point
What are the key assumptions of the Black-Scholes method ?
- Perfectly competitive and frictionless markets
- Continuous trading
- Normally distributed returns with constant mean and variance
- European option without dividends
What are the assumptions of the binomial option pricing ?
- Either up or down
- Call maturity 1 year and strike price X
- Compounding = continuous and rf bond price = 1
- Instantenous rf
What is the key idea of binomial option pricing ?
Find a replicating portfolio to find no-arbitrage price of option
What happens if the option has a different value of the replicating portfolio ?
Investors will buy (write) the option and short (buy) the replicating portfolio if option is less(more) than value replicating portfolio
The binomial option prie does not depend on …
• Probability of each state
• On risk preferences of investors
Investors = riks neutral !
What are two important possibilities one may miss if comptutes only CFs
- Epansion option
* Abandonment option
