FIN 630 Global Financial Management Unit 3 Group Project Alejandro Saez, Miesha N. Sailes, Jameel H. Shakir, Janet Romiluyi, Andrew Russo American Intercontential University September 1, 2013 This day and age has brought about an understanding of the value of intellectual property. Intellectual property is “an asset, and as such it can be bought, sold, licensed, exchanged, or given away” (Intellectual Property Valuation Part One of Four, 2000 para. 15). Intellectual property that companies own are “patents, copyrights, trademarks and identifiable know-how” (Intellectual Property Valuation Part One of Four, 2000 para. 13) by definition these IP’s can be considered identifiable intangible assets because there is no true way to show the physical makeup of these intellectual properties (Intellectual Property Valuation Part One of Four, 2000). When looking to value intellectual property there must be a way to measure or determine who or what owns the property and if this property has a monetary and or valued shelf life (Intellectual Property Valuation Part One of Four, 2000). Until recent, most businesses have not taken into account that they should include their intellectual property as a base for value and a way of generating revenue if the company chose to sale any forms of their “intangible assets”. For these reasons and the fact that if a company chose to license intellectual property concerning domestic and foreign business there must be methods formed to value these transactions. “Under Section 482 of the Internal Revenue Code, the appropriate transfer prices are subject to review by the Internal Revenue Service. Companies are required to justify intercompany transfer prices concerning the licensing and use of intellectual property by various foreign and domestic entities” (Valuation Approaches: The Market Approach, n.d.). Considering this factor, it is very important that ACME, understands the basic methods for valuing your intellectual property. A new way of doing business has emerged and it has created a very lucrative addition to companies revenue generated; such as when AOL sold some of their intellectual property which contained “800 patents, and 300 right to license to Microsoft for more than $1 billion” (Wild, 2013 p. 8). Now that was a great way to increase revenue for AOL, so they thought. Microsoft in turn took that purchase and sold “650 of those patents to Facebook for $550 million” (Wild, 2013 p. 8). The winner of this deal was clearly Microsoft. They saw how they could obtain patents which are considered intellectual property and sell them to make a profit. Corporations are getting smarter these days when it comes to understanding the value of intellectual property. Since intellectual property value has just recently become something that companies are considering very valuable, the methods for valuing these properties can be complex. Within this brief there will be a discussion of the current state of valuing intellectual property by focusing on the pros and cons of the market approach, cost approach and the income approach. There will also be examples provided for these approaches for better understanding of these valuation methods. Market Approach The market approach to valuing an intellectual property is based on the idea of competition in such that the company will look at a comparable asset to see what its value is and base their value off of those findings (Valuation Approaches: The Market Approach, n.d.). It is a straight forward approach that requires research and comparison of the same or similar intellectual properties. Considering this is a fairly new process of valuing intellectual property there might not be a lot of information available or the information may not seem very credible (Ashton & Upton, n.d.) to form an accurate comparison for valuation. This approach can be very difficult to use because of this. If information can be located this method can be easy to comprehend and it is an acceptable method by those looking to acquire intellectual property (Valuation Approaches: The Market Approach, n.d.). An example of the way in which the market approach can be used is by the looking at the purchase or sale of a patent. If ACME could acquire enough information on a comparable asset such as the recent sell of a patent that is similar to a patent that you all wish to purchase or sell this method can be used. It can be used because the similar asset information is available and you all can feel comfortable with purchasing and or selling the patent at a value that is acceptable within the market. Cost Approach A cost approach is a way of determining the value of Intellectual Property (IP); this is done through aggregating all the cost that is involved in the development of the IP. While this may sound simplistic, there is much more to it; it is not just a form of adding up all the cost that is involved in setting up an IP. There are two types of cost approach, one is the reproduction cost and the other is the replacement cost. When it comes to reproduction cost, this “is the level of expenditures needed to reproduce an exact replica of the asset” (Martin & Drews, 2010). This methodology is most appropriate when there is a process that can lead to legal action, specifically when responsibility is in question. Replacement cost measures the expenditures that are necessary to develop an asset with similar utility and is appropriate in circumstances such as determining an actual price for the asset, setting a target price prior to any negotiations, or calculating a basis for suitable royalty rates or transferring of prices (Martin & Drews, 2010). Only the funds that are necessary in order to reproduce or replace any of the assets of the product should be stated in the cost approach in order to notify management of the changes that could potentially happen. Another relevant cost that should be included in the cost approach is that of any research and development cost, and approval costs that are required for the project to get an approval for production. Other cost includes IP protection cost, capital investment, and any equipment that is necessary for production of the asset. Not every cost that is encountered should be entered into the cost approach, only those that would be required for the asset or assets that is of the same utility (Drews, 2001). The pros of the cost approach in valuing intellectual property are that it relates to the cost that is needed to replace a product by purchasing or developing a similar product. The cost approach is mostly useful in situations where there is limited data available that would indicate the fair market value of the product (Stephens, n. d.). Another benefit that the cost approach has it that it takes into account all that is needed in order to make the product which includes the fees that come from labor and other direct expenditures; such as research and development of the product. It also takes into consideration any out of pockets expenses that are needed to develop the product, all these are functions that are applied in the cost approach in order to understand the actual cost in order to produce and reproduce the product. The cons of the cost approach are that it has limited functions because the economic benefits from the IP are not always commensurate with the cost of developing the product (Stephens, n. d.). Its main use is in the preparation of notional valuations used to apportion the price of a business among its underlying assets in an income tax or financial reporting context (Stephens, n. d.). One example that could be used to describe cost approach would be: replacing an existing workforce. One of the main functions would be to look at the cost and time that it will take to recruit, hire and train the new workforce. There must be notation of the compensation level of each new employee; which includes the level of education and the experience that they have. This cost has to be added to the current compensation level and apply all the new cost that will be set in place such as: recruitment and training factors as well as the replacement cost. Through this cost, there are factors that come into play such as functional obsolescence, would the company need to hire the same amount of workers or will the company have excess capacity. Another factor that comes into play is that of economic obsolescence, would the company hire young workers that have more education in order to replace older workers that are less productive. Once all these factors are computed into cost approach, the company can then decide if it is a wise choice to go ahead and replace the existing workforce. Income Approach The income approach to valuation attempts to illuminate the economic value of an intellectual property. In this case, intellectual property could range from a physical patent to the development of a new service. This approach is most effective when the discounted cash flow theory is used to depict the value of a given intellectual property’s PV of the forecasted after tax benefits accumulated during an IP’s lifecycle. The income approach determines the approximate value of IP’s by predicting income or cash flow involving business operations, in relation to parts of service or product line of an organization. Cash flow is then discounted using present value equations that calculate the current value. Then a portion of this value is attributed to the intellectual property. Meaning a portion of the free cash flow from operations is credited to intellectual property. When using the income approach, specific consideration is given to five variables that establish value. (1) Revenue or income related to the IP use. (2) Anticipated escalation of uniqueness of the recognized revenue or income. (3) Expected length of time revenue or income is to be seen. (4) Danger coupled with creating the assumptions of revenue or income. And, finally (5) the amount of the revenue or income to which is to be allocated to the IP. These variables take in consideration the interpretation of applicable markets, together with size, growth trends, market share dynamics among participants and overall market risk characteristics. All inclusive facts of the characteristics of certain intangibles is significant, in addition to phase of improvement, specific attributes like financial degradation or segment control, and appropriate pricing information linked to products which present the IP. (Sharma, 2013, p. 4) In order to calculate the value of a particular IP we must first calculate current corporate value meaning the value of the organization as a whole. To do this, the following equation is to be used according to Ehrhardt& Brigham (2010): Value=〖FCF〗_1/〖(1+WACC)〗^1 + 〖FCF〗_2/( (1+WACC)^2 )+⋯ Once corporate valuation is determined, the value added by the new or existing IP can be calculated. It must be remembered that the five variables in which govern IP’s take president in determination of IP value. To determine IP value the DCF valuation model is to be used. DCF procedures involve three inconveniences, which are; the forecasting of future cash flows, the assimilation of taxes, and the resolution of the suitable cost of capital. The DCF model is as follows: DCF=CF_1/〖(1+r)〗^1 +CF_2/〖(1+r)〗^2 +⋯ +〖CF〗_n/〖(1+r)〗^n CF= Cash Flow r= Discount rate (Ehrhardt & Brigham, 2010). It is generally accepted that if the cost out weights benefit then the value added by and IP is not large enough to continue and thus must be terminated. On the other hand, if an IP shows growth in value added and Benefit out weights cost then it is assumed that the intellectual property is worth the time of incorporation. Taking in consideration cost and benefit, it must be understood that value added by an IP, those cost, and benefits will fluctuate from year to year. This phenomenon is mostly present because of a few given factors in economics. Advantages of the income approach over the other approaches, is that there is no need for market dealings because it holds anticipated future earnings to the owner without the need for similar market dealings. Though forecasted cash flows are necessary, they are based on cash flows of income produced by technology, and they are based on the costs saved by the technology. The income approach calculates the present value of cash flows from an IP asset, on the basis of discount rate which takes into account the organized risk. It shows the association between ROI on a security and the returns on market portfolio. Income approach takes into consideration the organized aspect of risk, which is calculated by the CAPM technique, the statistical measure of organized risk is shown by ß (Beta). (Sharma, 2013, p. 11) It also looks at the capitalization rate which is applicable over a discrete time allowing for the value to be presented for the sum of the present value for the lifetime which allows for changes in income from the asset (Ashton & Upton, n.d.). Disadvantages of income approach is that it demands biased cash flow allotment, conversion of theory into practice that demands guess work which is limiting to perception based on experience, and pertinent information is not always enthusiastically available from internal reporting systems. (Sharma, 2013, p. 12) One example of how the income approach can be applied is by looking at an apparel manufacturer, acting as the licensee, using the brand or logo of a popular sports team, the licensor. Using this example, the expected value of the licensing deal would be considered before the licensee or licensor would enter into a contract. This is first determined by calculating how much the licensee would make using the deal if the licensor was not part of the equation. Some of the sales costs associated with manufacturing of the apparel would include sales, prices, costs, and operating profits for apparel sales using the trademark or logo. The next part of the equation involves determining how much money, in incremental sales, both the licensor and licensee will make by licensing the property or asset being branded. The incremental benefit is used to determine how much the apparel manufacturer makes using the brand or logo as opposed to how much they will make using their own generic brand. The incremental value is then used to calculate, usually over a period of years according to the contract, how much the licensor will make by allowing their logo or trademark to be replicated for sale. Conclusion In today’s society there are several ways to communicate the value of a company. The initial way is having one’s company quoted in a market list. This allows potential and current shareholders to see how the company compares with others. Or, one can perform the methods mentioned above to formulate or estimate the added value to a company by looking at its intellectual property. Due to the newness of these methods Acme can choose to hire a consultant to perform these tasks. Hiring an outside source has its advantages and disadvantages. An advantage to hiring a consultant is the convenience. He/she prepares this information, which allows the company’s employees to be free to perform other tasks. This can allow for more production and more output of product or service. The disadvantage of hiring someone instead of having an in-house manager or employee tackle the project is that you all will have to pay that person. As you all at ACME can see, there are strengths and weaknesses as it pertains to these methods for valuing intellectual property. There are other ways of valuing intellectual property but they fall under the three main methods which are the methods that were discussed, the market approach, the cost approach and the income approach. An understanding of these fundamental concepts and how they are being used in today’s market is essential for adding value and revenue from sells of intellectual property to your company. These are fairly new concepts but that should not deter your company from reaching above and beyond its current state of value by taking advantage of the intellectual property market and the intellectual property that your company currently owns.
Posted on: Mon, 02 Sep 2013 05:03:24 +0000
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