Valuation of technology using "real options"

Cash flow models for valuing technology are increasingly out of touch with market-place valuations. While investor psychology and perceptions about th e future may drive the marketplace, the theory of real options can go a lon g way towards closing the valuation gap. More importantly, it is a quantita tive method, and is responsive to changing sets of assumptions. This articl e focuses on the importance of separating unique and market risk in applyin g options theory to R&D projects, since the former impacts value negatively while the latter enhances value. It also illustrates how the hidden option s in a new venture can contribute enormously to value, especially in fast-g rowing industries and in market exhibiting high volatility.