Valuing Growth
Jonathan Berk, University of California at Berkeley
Vasant Naik , University of British Columbia
Richard Green, Carnegie-Mellon University

The paper, “Valuation and Return Dynamics of R&D Ventures,” develops and analyzes a model of a multi-stage investment project that captures many features of R&D ventures and start-up companies. An important feature these problems share is that the firm learns about the potential profitability of the project throughout its life, but that “technical uncertainty” about the research and development effort itself is only resolved through additional investment by the firm. In addition, the risks associated with the ultimate cash flows the firm realizes on completion of the project have a systematic component, while the purely technical risks are idiosyncratic. Their model captures these different sources of risk, and allows them to study their interaction in determining the risk premium earned by the venture during development. The results show that the systematic risk, and required risk premium, of the venture are highest early in its life, and decrease as it approaches completion, despite the idiosyncratic nature of the technical risk. (Accepted Spring 1999.)