08 - Real Options

08 - Real Options - Venture Capital & Private Equity...

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Venture Capital & Private Equity Valuation using Real Options aluing Uncertainty with Real Options Valuing Uncertainty with Real Options Professor David Wessels © 2008 The Wharton School of the University of Pennsylvania 3620 Locust Walk, Philadelphia PA 19104
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Venture Capital & Private Equity Valuation using Real Options Value Creation at Amgen Not every company generates iti d positive spreads. When companies are not earning the cost of capital, you must ROIC at Amgen, Inc. 1984-2003 80% assess two questions: How long will it take before the company starts creating value? 20% 40% 60% How large will the initial investments (or losses) be? Amgen failed to earn its cost of 0% -40% -20% 0% 1984 1988 1992 1996 2000 capital until Epogen, its blockbuster drug, was approved by the FDA. -60% *ROIC measured as three-year rolling average Professor David Wessels The Wharton School of the University of Pennsylvania 2
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Venture Capital & Private Equity Valuation using Real Options Basic Valuation Framework Key Inputs evenue growth ow fast is the Atricure, Inc. Intrinsic Valuation Model 1. Revenue growth. How fast is the market growing? How fast is the company capturing relevant share? 2. Operating margin. What do established companies in the field $ millions 2006 2008E 2009E 2010E 2011E 2012E Revenues 38.2 58.9 72.8 87.4 100.5 110.5 <------------------------------ Forecast ----------------------------> 1 generate in margins? 3. Operating tax rate . Does the company have tax loss forward to shield future taxes? i d i t t h Operating profit (EBIT) (14.8) (9.9) (4.2) 3.5 16.1 27.6 Operating taxes 0.4 0.3 0.1 (0.1) (0.4) (0.7) A/T Operating profit (14.4) (9.6) (4.1) 3.4 15.6 26.9 Normalized investment (6.6) (4.5) (4.7) (4.2) C.V. Expected cash flow (16.2) (8.6) (1.3) 11.4 221.1 2 3 4 4. Required investment. How much capital is required to grow the business? 5. Terminal value. What is the appropriate terminal multiple? Discount factor 1.074 1.154 1.239 1.331 1.331 Discounted cash flow (15.1) (7.4) (1.0) 8.6 166.1 Key Ratios 6 pp p p Industry medians never work! 6. Discount rate . For venture funded companies, the discount rate should be determined by the CAPM, not Revenue growth 23.5% 54.0% 23.7% 20.0% 15.0% 10.0% Operating margin -38.6% -16.7% -5.8% 4.0% 16.0% 25.0% Capital turnover 3.12 3.12 3.12 3.12 3.12 3.12 Source: Worldscope, Thomson Financial, Wharton Financial Analysis Professor David Wessels The Wharton School of the University of Pennsylvania 3 arbitrary rates!
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Venture Capital & Private Equity Valuation using Real Options Decision Tree Analysis Your firm has developed a new miconductor which transmits data using What is the expected ROIC and PV of the new investment? semiconductor which transmits data using light, not electricity. Development of the product is expected to cost $350 million. isco has offered to license the product NPV of the new investment? C sco s o e ed o ce se e p oduc from our company. If the product can be incorporated broadly, Cisco has agreed to pay $25 million in after-tax cashflows per year every year forever. If it can only be used in niche products, it will generate $5 million in after-tax cashflows per year rever. forever.
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08 - Real Options - Venture Capital &amp; Private Equity...

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