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Funding Decisions For Multi Stage Projects

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Conference

2010 Annual Conference & Exposition

Location

Louisville, Kentucky

Publication Date

June 20, 2010

Start Date

June 20, 2010

End Date

June 23, 2010

ISSN

2153-5965

Conference Session

Frontiers in Engineering Economy

Tagged Division

Engineering Economy

Page Count

11

Page Numbers

15.607.1 - 15.607.11

Permanent URL

https://peer.asee.org/15803

Download Count

130

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Paper Authors

biography

Neal Lewis University of Bridgeport

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Dr. Neal Lewis received his Ph.D. in engineering management in 2004 and B.S. in chemical engineering in 1974 from the University of Missouri – Rolla, and his MBA in 2000 from the University of New Haven. He is an associate professor in the School of Engineering at the University of Bridgeport. He has over 25 years of industrial experience, having worked at Procter & Gamble and Bayer. Prior to UB, he has taught at UMR, UNH, and Marshall University.

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biography

Ted Eschenbach TGE Consulting

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Dr. Ted Eschenbach, P.E. received the MCE degree in 1998 from the University of Alaska Anchorage. His masters in operations research and his doctorate in industrial engineering are from Stanford University. He is the principal of TGE Consulting, an emeritus professor of engineering management at UAA, and the founding editor emeritus of the Engineering Management Journal. His engineering economy texts are published by Oxford University Press.

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Joseph Hartman University of Florida

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Dr. Joseph C. Hartman, P.E. received his Ph.D. in 1996 and M.S. in 1994 in industrial engineering from the Georgia Institute of Technology and his B.S. in general engineering from the University of Illinois at Urbana-Champaign in 1992. He is a professor in the Department of Industrial and Systems Engineering at the University of Florida and serves as department chair. His research interests are in economic decision analysis and dynamic programming. He is an active member of ASEE, IIE, and INFORMS and currently serves as editor of The Engineering Economist.

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Abstract
NOTE: The first page of text has been automatically extracted and included below in lieu of an abstract

Funding Decisions for Multi-Stage Projects Abstract Large industrial projects are generally organized and funded in stages, with each stage funded and executed sequentially. This is widely practiced with new product and new technology development projects, venture capital projects, and natural resource development projects. It is required and regulated for pharmaceutical projects. Continued funding of a project generally requires the successful completion of a stage.

The methods used to value multi-stage projects are derived from the fields of finance and engineering economics. Traditional valuation techniques for multi-stage projects are based on decision trees; this is the primary method taught to engineering students. Proponents of real options have suggested that options analysis more closely follows the assumptions used in actually funding a project, but these new methods have other, unresolved problems.

Introduction Firms often undertake large investments in stages1. Rather than invest all required funds at the beginning of a large project, many firms will make a series of sequential investments based on the success of previous investments. Many projects involve multiple stages, and multi-stage economic analysis is often necessary. An example of a multi-stage project is pharmaceutical drug development, where new drug products must pass a series of clinical trials, and where successive clinical trials are performed (or not) depending on the success of the previous clinical tests. That is, Phase II tests are only performed if Phase I tests are successful, and Phase III testing is conducted only if Phase II is successful. Staged funding also occurs in many other large projects, where new ideas pass from concept development to product design and development to engineering, creation of manufacturing capacity, and product introduction into the marketplace. Each stage involves rapidly increasing monetary commitments, and each stage is funded only if the previous stage is successful — and not necessarily even then. For example changing markets, new drugs from competitors, and more promising drugs may stop a drug after a successful clinical trial. This paper is an initial analysis of stage-gate funding and it assumes that a successful clinical trial implies continuing with development. Staged funding is a method of managing the investment risk. While at each passed stage the probability of the drug reaching the market increases, the increasing financial stakes imply increasing amounts of risk.

Current methods for determining the value of staged projects use NPV analysis based on expected costs, expected revenues, and the probabilities of passing from one stage to the next. Decision trees are often used to organize the information and to calculate project value. Real options analysis can use compound options to determine an expanded net present value (ENPV) of a staged project. In high risk, high payoff projects, such as drug development, where the probabilities of moving forward are fairly low, options analysis may provide a different, and possibly more positive, project assessment. There is a possibility that options analysis will provide a more accurate project valuation than traditional methods if existing problems and concerns that exist with real options can be overcome.

In this paper, we examine the issue of staged funding. Engineering economics, finance, and project management textbooks are first reviewed to determine the extent to which we are

Lewis, N., & Eschenbach, T., & Hartman, J. (2010, June), Funding Decisions For Multi Stage Projects Paper presented at 2010 Annual Conference & Exposition, Louisville, Kentucky. https://peer.asee.org/15803

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