
The Method of Real Options to Encourage the R & D Team239
5.2 Real Option Incentive Program
Now if we consider real option, the evaluation to the
project is entirely different. When R & D in the first
phase was completed, cash flow was only 33.08 million
in the poor market (that is, cash flow expected value after
one year in poor market: ), if we
switched to another product at this time, the value of the
previous R & D was 50 million. Obviously, such a con-
version opportunity is valuable. Actually it is option to
switch: the agreed price is 50 million, maturity period is
1 year, the current price of the subject is 49.62 million
(hat is, expected value of current cash flow, [(
21.08+12=33.08
105.42 60)
), maybe
rise to 165.42 million (that is, expected value of cash flow
after one year in good market: 105 )
or drop to 33.08 million due to date (that is, expected
value of cash flow after one year in poor market:
). We can use
0.221.08 120.8] ()
21.08+12=33.08
(1 20%)49.62
.42 + 60 =165.42
binomial tree model
[16] and set up the probability of price raise is “P”. With
the hypothesis of symmetric information and risk-neutral,
we can get the value of this real option at risk-free inter-
est rate of 3.87%, which is bank interest rate for
one-year.
0.0387
165.4233.08(1) 49.62PPe
0.1398P
That is to say, the probability of the call option is
13.98% of which value is 55.8 million (165.42 50
). And the probability equals 1 - P when the
value of the call option is zero, that is 86.02%.
115.42
Expected cash flow of the option to switch is:
115.42 13.98%086.02%16.13
Discount at the risk rate of 20%, get current value of
option to switch:
16.13 / (120%)13.44
Therefore, project team will be able to share a part of
this value as an incentive with real option incentive ap-
proach when finished the first phase. The firm can de-
termine the proportion αi as 10% based on strategic ob-
jective and current industry competition. So, R & D team
may get 1.344 million as a reward. It is reasonable for the
both because this project can build foundation for an-
other product’s R & D and contribute to the company’s
development. Considering that being start-up period and
need more liquidity for more follow-up R & D projects,
the company decided not to use bonus but share the value
of latter project in the future.
5.3 Comparative Analysis about Advantage of
Real Option
The high-risk project is common for any firm. Real op-
tion incentive put forwarded in this paper is one of ways
to solve how to encourage R & D team in such project,
which advantages include: 1) to avoid short-term goal-
oriented, companies can determine benchmarks of team
incentive based on the follow-up value of high-risk pro-
ject; 2) To design more flexible incentive methods,
companies can use different types of real option or de-
sign different exercise methods; 3) If we combine real
option incentive with other motivation methods, the ef-
fect will be more targeted-oriented and more comprehen-
sive.
6. Conclusions
This article discusses the method of real options to en-
courage R & D team when the enterprises can not
achieve the desired economic benefit in the case of
high-risk project or the immature market. The steps of
method include: identify the real option type of high-risk
projects, design the incentive mechanism and design
specific exercise ways. In fact, real option presented in
this paper can be applied not only to high-risk project,
but also to other technical project. In addition, some
non-material incentives, such as honor or job promotion,
will bring more opportunities for R & D team, which
itself can be regarded as one of real options. How to
quantify the value of these non-material incentives ap-
proach and combine with other materials will be our next
research direction and focus.
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