R&D Portfolio Valuation and Formation

Abstract

Chapter 3 confronts the challenge ofpredicting the return on R&D investments before they are made. It critiques traditional government methods that apply discounted cash flow analysis to individual R&D projects in isolation. Option theory and portfolio theory are used to identify potential enhancements to traditional methods. Chapter 3 also demonstrates that focusing exclusively on potential returns while ignoring risk is a fundamentally unsound practice. Methods often used by the private sector to form, value, and manage portfolios of R&D projects are summarized, including the “bucket” method, quantitative multi-objective methods, static choice methods, and dynamic management methods. While a portfolio perspective is rarely taken within government R&D programs, a few examples are identified and characterized.