CASE STUDY: ARCADIAN MICROARRAY TECHNOLOGIES, INC.
As an investment manager from Sierra Capital Partners, Rodney Chu is interested in purchasing a 60% equity interest of Arcadian Microarray Technologies, Inc., a biotechnology firm. The bid is currently at $40 million. The Arcadian’s managers have optimistic projections for their firms’ performance over the next 11 years. However, based on Sierra’s calculations, come up a much more conservative view. With the request of Mr. Chu, a fair bid price could be calculated along with any appropriate counterproposals. Appropriate steady state growth rates and terminal values would be included and explained.
The main objective of this paper is to exercise the terminal value of a firm. The other objectives are to acknowledge: 1. Concept of terminal value
2. Various terminal value estimators along with its advantages and disadvantages 3. The use of tax on terminal value
4. Assumption on liquidation
5. Forecast horizon for estimating terminal value
6. Constant-growth valuation model and its derivation
7. Fisher’s formula for estimating growth rate to infinity 8. Triangulation of a terminal value estimate.
We could see in the case that the lessor was trying to understand the lessee’s point of view. Thereby, the lessee’s financing problem is the lessor’s investment problem. This perspective would be explained thoroughly below.
2.1. Presentation and explanation of data in Exhibit 3
Based on Chu’s view, terminal value mostly affects stock price. The sample of Exhibit 3 is shown below.
The calculation would be:
2.2. Consideration and approaches described in Exhibit 4
Exhibit 4 provides an opportunity to discuss the applicability of a wide range of terminal value estimators. The point of this discussion should be to show that, in selective circumstances, each approach could give a fair estimate of market value. For instance, Book values might be realistic in mark-to-market accounting situations, where the firm has just started up, or where the firm consists substantially of working capital. On the other hand, Liquidation estimates would be more realistic in cases where the firm will indeed liquidate. Replacement values might indicate market values where the firm experiences high inflation. In any comparison to this, DCF and multiples give very direct estimates of market values. DCF will dominate where the firm has no earnings to capitalize or when assets consist mostly of intangibles that are not currently reflected in earnings.
2.3. Assessment on forecast horizons for the three projects in Exhibit 5
On the figure above, we can see that the terminal value is used as the horizon in forecasting the three projects. We also have to consider the condition of when we should set the terminal value. The key to set the horizon is when the stable growth of forecasted cash flows begin. When the stable growth begins, stop forecasting the cash flow and estimate the terminal value.
The calculation of the growth is as follows:
2.4. Interpretation of Exhibit 6
Price to Earning Ratio
Price to Book Ratio
2.5. Driver of “g”
Constant Growth Rate
1 Real growth rate in the economy = 3%
2 Real growth rate in the Pharmaceutical Industry = 5%
3 USA Population growth = 1%
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%
2.6. Estimation of terminal values by using multiples and preparation of present value by using them
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