Multi-stage evaluation of R&D IT projects - Based on compound options

Considering the characteristics of IT R&D, this paper introduced the concept of compound options into the evaluation of IT R&D investment, and proposed a compound options approach to evaluate multi-stage investment. This paper divided R&D project into three stages, including pre-experiment, large-scale research and commercialization. The options comprised in these three stages were viewed as compound options to be priced and evaluated. Referring to different features of these three stages, three approaches, i.e., binomial decision tree of single option, binomial decision tree of multi-stage options, and modified B-S model with a risk-averting investor, were set up to evaluate the values of these three stages respectively. Moreover, a systematic pricing model which is easy to operate on practical evaluation of IT R&D investment options was discussed. Finally an example of the value evaluation for an IT R&D investment project was given to demonstrate the application.