A Financial Model to Assist New Therapeutics Development Decision Making

Abstract

Biotech is an industry that is heavily reliant on the risky Research and Development process. While the biotech projects are most often valued with Discounted Cash Flow (DCF) methods, the risk and the phased development process of the biotech industry make it an ideal process to be valued by a real options approach. This thesis tries to use the binomial lattice method based Real Options Valuation (ROV) technique to evaluate Aduhelm, a recent high-profile failure in the biotech industry, and compare the valuation with Discounted Cash Flow (DCF) and Decision Tree (DT) methods. All three models were able to generate similar overall predictions to the change in Biogen’s market capitalization but ROV and DT performed better in earlier stages by capturing the option value in the process. None of the models would have automatically predicted Aduhelm’s market failure without the manager changing critical valuation assumptions. Regardless of the valuation models used, Managers should apply careful judgment and adjust assumptions as more information is gathered during the development process to ensure optimum investment decision making.