OBJECTIVES: This paper presents a model based on real option analysis for the valuation of R&D in the pharmaceutical sector both for start-up ventures as well as big conglomerates. We derive a formal compound option model to value New Drug Applications (NDA) and show the valuable contribution of real option analysis compared to conventional DCF-analysis. METHODS: The key understanding is that R&D projects of NDAs can be seen as compound options. The growth option framework looks at pharmaceutical investment projects as a sequence of options, which differs from a conventional DCF-analysis by incorporating the possibility to stop the project when a subsequent phase is not valuable (abandon the option), and only continues with the project (exercising the option) when it is valuable. Traditional valuation techniques as DCF-analysis fail in valuing innovative companies because most of the value of R&D projects is embedded in unexercised real options whose future value is uncertain at this moment. If one considers a company as a portfolio of real options, one can value the projects or the company based on a compound option model. RESULTS: The compound option model reveals that real option analysis can better incorporate the value of a NDA than conventional DCF-analysis would reveal. Real option analysis will better reflect the fundamental value of the project or of the company, which cannot be captured by DCF-analysis. CONCLUSION: The paper presents a new methodology for valuing R&D of pharmaceutical companies based on compound option models.