Valuation of intellectual property

Abstract

Purpose This paper aims to provide a new approach to evaluate intellectual property (IP) and uses a cautious view of how volatility impacts the economic value of IPs. Design/methodology/approach Real option is a useful tool for valuing investments under uncertainty and if it is applied to the valuation of IP with some modifications, it is also widely accepted. However, it is still debatable whether there is a constant rate‐of‐return. This paper incorporates a sensitivity variable to account for the volatility of the expected rate of return. Thus, rate‐of‐return can be a constant or increase with volatility. Findings First, it was found in the simple model that Vega may be negative when the option is deep in the money. Second, in the general model, the option can be seen as a sequence of options and under the constant rate‐of‐return shortfall setting, it resembles traditional financial options with positive Vega. Originality/value The scenario set‐up allows the authors to explain why uncertainties of future cash flows drive firms to invest now instead of later.