Valuation methods in Project Portfolio Optimization - Focus on Real Options

Abstract

Valuation methods are critical supporting tools for any decision in Project Portfolio Management, so as to optimize the project portfolio in terms of expected return. This article quickly presents with general valuation techniques for generic portfolio management (NPV, DCF, see below), but might be more relevant as applied to R&D portfolio selection and optimization.

A project portfolio is optimized by evaluating a multi-objective ranking based on (1) the expected return, (2) the uncertainty, and (3) the strategic fit, while optimizing several budgets allocation:

• Financial budget,
• Technological or knowledge-based budget,
• Budget based on the market uncertainty
• Critical resources allocation budget

R&D portfolios optimization is based on project valuation, and an alternative to classical methods such as NPV (Net Present Valuation) and DCF (Discounted Cash Flow) is the real options valuation.

The core principle is similar to the principle of financial options: holding a decision which is to be made is equivalent to have an option, which can be valued. The only difference is the materiality of the option (‘real’), as opposed to the abstract nature of a financial option.