Akua Acheampong Jody Grewal Kieng Iv Rhea Rasquinha

 Background and Current Issues  Terminal Value  Estimators of Terminal Value  Forecast Horizon  Quantitative Analysis  Recommendations

 Arcadian: Gene diagnostics industry  Investment Opportunity: Original Offer: 60% equity interest in Arcadian for $40M  Value of the Investment: Determined through estimating terminal value

 It is the lump sum of cash flows at the end of a stream of cash flows, which represent: The proceeds from exiting an investment; The present value of all cash flows beyond the forecast horizon  Terminal values are important because: They are present in the valuation of almost every asset They measure the “continuing value” derived from the going concern of the business.

Importance of Terminal Value

Terminal Value Liquidation Assumption Liquidation value Going Concern Assumption Market Multiples Constant growth

ApproachAdvantagesDisadvantagesWhen to use approach Book valueSimple Ignores some assets and liabilities Historical cost: backward looking Subject to accounting manipulation Appropriate when the minimum value of a company needs to be determined. Replacement Value Current Subjective estimates Value may be difficult to come by Appropriate when a company is deciding whether to buy another company or build a new one from scratch. Liquidation Value Conservative Ignores going concern value Uncertainty about value of assets in the market Appropriate when assets are marketable Multiples Simple Widely used “Earnings” subject to accounting manipulation “Snapshot” estimate: may ignore cyclical, secular changes Provides relative value, not absolute value The approach is used as a business valuation benchmark Constant Growth Method Reflects the time value of money Errors in growth rate and/or discount rate can provide improper value Easy to abuse or misuse Requires estimate on when firm will grow at stable rate Appropriate when cash flows are strong and relatively consistent

Terminal Value Forecast HorizonCash Flows beyond the Forecast Horizon Going Concern Timeline Importance: All future cash flows, not only the ones that you can forecast, determine value PV of future cash flows beyond the forecast horizon As far into the future as CFs can be forecasted KEY: When Stable Growth Begins… Set the forecast horizon Stop Forecasting Cash Flows Estimate a Terminal Value

1 Projected Cash Flows by Investment ($150) ($100) ($50) $0 $50 $100 $150 $200 $250 $300 $ Year $Millions Movie Studio Bottling Plant Toll Road Stable growth of 2% begins in year 27: -Production capacity reached -Estimate TV at yr 27 Stable growth of 2% begins in year 12: -Plant reaches capacity -Estimate TV at yr 12 Stable growth of 2% begins in year 3: -Operational capacity reached -Estimate TV at yr 3

Very unstable growth Resembles Bottling Plant

 Limitations: Forecasts for 10 and 11 years, but neither attains stable growth Ideally, we should continue forecasting until stable growth begins  Difficult due to the company being in its early stages  When should TV be estimated? At end of 2013?  Cash flow growth is volatile after 2013 At end of the Forecasted Cash Flow period?  Cash Flow growth has declined and will further decline until 5% is reached It is reasonable to assume that growth will fall to 5% by 2016 given the pattern of decline since 2013 Use the End of the Forecasting Period to Estimate TV

Best Options: 1.Price/Earnings Ratio 2.Price/Book Value Ratio 3.Constant Growth Rate Assumptions: 1.WACC – 20% 2.At end of forecast horizon Arcadian is a mature company

Options: 1.Real growth rate in the economy = 3% 2.Real growth rate in the Pharmaceutical Industry = 5% 3.USA Population growth = 1% Nominal Rates 1.Nominal growth rate in the economy ~ 5% 2.Nominal growth rate in the Pharmaceutical Industry ~ 7% 3.USA Population growth = 1% Best Rate: Nominal growth rate in the economy ~ 5% Inflation=2%

Low Range High Range

ArcadianSierraDifferenceApplicable Price/Earnings Ratio Low End: 15 High End: No Price/Book Ratio No Constant Growth Rate Yes

ArcadianSierraDifference Constant Growth Rate

 Option on Future Opportunities  Further financing needed 40M barely covers 2005 projected cash deficit Debt financing  High debt financing costs: low current earnings -> low interest coverage, low operating income margin -> high cost of debt  Impact on WAcc  IPO/Early Exit Distribute shares to clients tax-free Compare with  Affymetrix (P/E 50.09, P/B 8.56,P/FCF 97.5, P/SALES 7.49)  Illumina (PB 8.46, P/SALES 8.82)  Current Average Investment weighting: $31.25M

Counteroffer: $21M Abandonment Point: $31M Management Bonus  If management hits forecast in years , 5% incentive  $2M present value