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

Approach

Advantage
s

Disadvantages

When to use
approach

Book value

Simple

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.

Replaceme
nt 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

Conservativ
e

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

Going Concern Timeline

Forecast Horizon

Cash Flows beyond the

Forecast Horizon
Terminal Value

As far into the

future as CFs can
be forecasted

PV of future cash
flows beyond the
forecast horizon

KEY: When Stable Growth Begins

Set the forecast horizon
Stop Forecasting Cash Flows
Estimate a Terminal Value

Importance: All future cash flows,

not only the ones that you can
forecast, determine value

Projected Cash Flows by Investment

$350
$300
$250

Movie
Studio
Bottling
Plant
Toll Road

$Millions

$200
$150
$100
$50
$0
($50)

($100)

9 11 13 15 17 19 21 23 25 27 29

Year

($150)
Stable growth of 2%
begins in year 3:
-Operational capacity
reached
-Estimate TV at yr 3

Stable growth of 2%
begins in year 12:
-Plant reaches capacity
-Estimate TV at yr 12

Stable growth of 2%
begins in year 27:
-Production capacity
reached
-Estimate TV at yr 27

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%

Fisher Equation

Inflation=2%

g No

(
1

g
)
x
(
1

g
min al
Re al
Inflation ) 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%

High Range

Low Range

Arcadia
Sierra
n

Difference Applicable

204

125

79

No

303

191

112

No

Price/Book Ratio

462

66

396

No

Constant Growth
Rate

31

21

10

Yes

Price/Earnings
Ratio
Low End: 15
High End: 20

Constant Growth
Rate

Arcadia
n

Sierra

Difference

122

92

30

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
2013-2014, 5% incentive $2M
present value