Valuation of technology using real options

Cash flow models for valuing technology are increasingly out of touch with market-place valuations. While investor psychology and perceptions about the future may drive the marketplace, the theory of real options can go a long way towards closing the valuation gap. More importantly, it is a quantitative method, and is responsive to changing sets of assumptions. This article focuses on the importance of separating unique and market risk in applying options theory to R&D projects, since the former impacts value negatively while the latter enhances value. It also illustrates how the hidden options in a new venture can contribute enormously to value, especially in fast-growing industries and in market exhibiting high volatility.