Assessing Terminal Value In Microarray Technologies Case ✓ Solved

Assessing Terminal Value in Microarray Technologies Case

This case written assignment is on Arcadian Microarray Technologies, In. (Case 44). Report Requirements: · Cover sheet with case name, date, team number and team members; · One or two page written report analyzing questions given; and · Exhibit with any financials, ratios, charts/graphs that you address in your report. Your analysis should cover the following concerns:

1. Regarding the cash flow forecasts in case Exhibit 5, at what point in the future would you set the forecast horizon for the three investments? Why? More generally, what should determine when you stop forecasting annual cash flows and estimate a terminal value?

2. Estimate other terminal values based on alternate estimation approaches. From these various estimates, please triangulate toward a single composite estimate of terminal value for each of Sierra Capital and Arcadian’s forecasts. What is the resulting present value (PV) of cash flows under Sierra Capital and Arcadian’s outlook? How significant was TV in creating the difference between the two present value estimates?

3. As a general matter in valuation work, how much attention should terminal value garner? What short list of questions about TV could you keep on hand in case a client asked you to opine on a valuation of that company?

Sample Paper For Above instruction

Assessing terminal value is a crucial component of valuation, particularly for companies like Arcadian Microarray Technologies that operate in innovative and fast-evolving industries. Estimating the value of a firm beyond the explicit forecast horizon involves making assumptions about perpetual growth rates or applying exit multiples, which significantly impact the overall valuation. This paper discusses the appropriate timing for setting the forecast horizon, methods for estimating terminal value, and the significance of terminal value assessment in valuation practice.

Determining the Forecast Horizon

In valuation exercises, the forecast horizon refers to the period over which detailed cash flow projections are made. For Arcadian Microarray Technologies, the forecast horizon should extend until the point where projections become increasingly uncertain or where the company's growth rate converges with the industry or economy's typical long-term growth rate. Generally, a typical forecast horizon spans 5 to 10 years, depending on the industry stability and company maturity (Damodaran, 2012).

Given the high technological uncertainty and rapid innovation within the biotech and microarray sectors, a shorter horizon, such as 5-7 years, might be suitable for Arcadian. Beyond this period, projections tend to rely more heavily on assumptions about the terminal value, which should be estimated carefully to avoid overestimating future cash flows. The choice of the forecast horizon also influences the sensitivity of the valuation to the terminal value assumptions.

When to Stop Forecasting and Estimate Terminal Value

The decision to cease forecasting explicit cash flows hinges on several factors:

• Increasing uncertainty in predictions beyond the horizon due to technological or competitive risks.
• Attempting to forecast beyond the company's typical product lifecycle or industry maturity phase.
• Availability of reliable financial data and market indicators for the period.

At this point, it is appropriate to estimate the terminal value, which captures the continuing value of the enterprise beyond the explicit forecast period. A well-defined terminal value provides a bridge from detailed annual forecasts to a perpetuity or exit multiple approach, facilitating a meaningful valuation.

Alternative Approaches to Estimating Terminal Value

Several methods can be employed to estimate the terminal value, including:

• Perpetuity Growth Model — assumes cash flows grow indefinitely at a constant rate (Gordon Growth Model). For instance, if the company's free cash flows are expected to grow at 3% forever, the terminal value equals the last forecasted cash flow times (1 + g) divided by (WACC - g) (Damodaran, 2012).
• Exit Multiple Method — applies a valuation multiple (such as EV/EBITDA) derived from comparable companies to the terminal year's financial metrics.
• Hybrid Approaches — combining elements of both models for a more nuanced estimate.

Using these different methods provides a triangulation approach, allowing for a composite estimate that mitigates the biases inherent in any single technique.

Impact of Terminal Value on Valuation

In many cases, terminal value constitutes a substantial portion of the total valuation, especially when the explicit forecast period is relatively short. For Arcadian Microarray Technologies, estimates indicate that the terminal value could account for over 50% of the present value, underscoring its importance. Variations in the terminal growth rate or exit multiple can significantly alter the overall valuation, often more than the forecasted cash flows themselves.

Importance of Terminal Value in Valuation

Terminal value must garner adequate attention within the valuation process. Its sensitivity to assumptions about perpetual growth and discount rates means that a small change can lead to large valuation swings. As such, valuation professionals should critically evaluate terminal assumptions by asking key questions:

• What long-term growth rate is sustainable given the industry and macroeconomic environment?
• How do comparable companies' exit multiples support this estimate?
• What is the company's competitive advantage that could sustain cash flows indefinitely?
• Are there significant risks or opportunities that could alter long-term cash flows?
• Is the discount rate appropriately reflecting the company's risk profile?

In conclusion, the careful consideration of terminal value is essential for accurate valuation. It requires prudent modeling, sensitivity analysis, and a comprehensive understanding of the company's long-term prospects and industry dynamics.

References

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• Gordon, M. J. (1959). Dividends, earnings, and stock prices. The Review of Economics and Statistics, 41(2), 97–105.
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