A real options model for evaluating new drug discovery projects in pre-clinical phase

New drug R&D process, which may be divided into two phases, drug discovery and clinical trials, is vital for pharmaceutical firms to successfully launch drugs. Earlier studies about resource allocation and decision making in new drug R&D mainly focus on the clinical trials phase, and only little attention has been paid to the discovery phase. In practice, at the end of new drug discovery phase, the pharmaceutical company has to decide whether the project is to proceed to clinical trials immediately (invest), to be suspended temporarily, or to be abandoned entirely. This paper aims to investigate this decision-making problem by developing an approach incorporating Real Options Analysis (ROA) to evaluate new drug R&D projects. Important factors affecting the values of new drug R&D projects are modeled, including uncertainty of project's value, market competition, growth opportunity of the project, and related capital required to carry out clinical trials. This study aims to capture the interrelationship of factors and project values by examining different circumstances, and help pharmaceutical firms to optimize decision-making. The main goal of this model is to explore the impact of these factors on firms' optimal decision from the aspect of maximizing the value of projects.