A real options based decision support tool for R&D investment : Application to CO2 recycling technology

Deeney, Peter and Cummins, Mark and Heintz, Katharina and Pryce, Mary T. (2021) A real options based decision support tool for R&D investment : Application to CO2 recycling technology. European Journal of Operational Research, 289 (2). pp. 696-711. ISSN 0377-2217 (https://doi.org/10.1016/j.ejor.2020.07.015)

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Abstract

We propose a practice relevant real options based decision support tool to aid in the practical evaluation of R&D investments in technology. Using a Poisson process to simulate the discrete progress typical of advancements in R&D, we take explicit account of the technical risk of the technology development, while market risk exposure and the effect of learning-by-doing through operating the technology is also explicitly modelled. We present a compound real option design, where a European real option structure is used to model the fixed length term typical of early phase research, which is exercisable into an American real option structure to model a subsequent phase R&D. In this latter phase, a successful outcome is acted upon immediately to operationalise the technology. We propose a simulation approach, which models R&D progress in a stylised logistic function or ’S-shape’ 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 propose a business appropriate and workable economic meaning to this progress in the R&D process. We demonstrate the decision support tool with an application to evaluating the R&D investment potential in CO2 recycling technology, where an energy commodity is produced.

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