An application of the real options approach to R&D investment decision making in a service division of an energy firm

This study aims for the demonstration of the real options approach on valuing R&D projects and optimising the investment strategy to develop after-sales service products for thermal power plants in an energy firm. A compound option approach based on Geske’s analytical model with the volatility estimation through the questionnaire to experts was demonstrated to be an effective tool of R&D project valuation for decision-making. Furthermore, taking the quadrinomial lattice approach, considering the two important uncertainties of market and technology in R&D investment decision-making, applicability was demonstrated. From the relationship between the amount of R&D investment and the probability of technical success, R&D investment strategy was confirmed to be optimised using the approach. Furthermore, the R&D valuation process using real options approach tightens the relation between R&D division and sales division, to make market-orientated proposals.