Financial Modeling - The value of intangibles Flashcards
What are examples of intangibles assets that generate cash flows?
- Developed patents, copyrights, trademarks, and licenses
2. DCF adequately value
What are examples intangible assets that are not on the books but generate value?
- Brand name (eg. Coca Cola)
- Reputation (eg Nordstrom)
- Value of human capital (eg Apple)
What are examples of intangibles assets that have the potential to generate cash flows but do not now?
- Patents (eg. Pfizer and GSK)
2. Oil reserves (eg Noble energy)
What are features of some intangibles?
Traditional accounting rules ignore or undervalue them
- Don’t appear on balance sheet
- Significant effect on firm value
- Traditional measures used for valuation may distort value
What are 2 traditional measures used for valuation which may distort value?
- Profitability measures (ROE, ROIC)
2. Market multiples (P/E, EV/EBITDA)
What’s included in DCF for trademarks, copyrights, and licenses?
Include costs of violations and enforcement
What do you find in relative valuation for trademarks, copyrights, and licenses?
Find pure plays
What is a franchise?
A franchise gives its owner the right to market or sell a product or service of a brand-name company. (McDonald’s fast food restaurant)
For a franchise, what are sources of excess return?
- Brand name value (McDonald’s)
- Product/service expertise (eg special sauce)
- Legal monopolies (CBOE seat)
What is brand name value?
A franchise might have a brand name value that enables the franchise to charge higher prices and attract more customers
What is product/service expertise?
A franchise has value because the franchisor provides expertise on the product or service that is being sold.
What are legal monopolies?
Sometimes a franchise may have value becauase the franchise is given the exclusive right to provide a service.
What are 3 special issues with franchises?
- Problems of franchiser will affect franchisee (and are not within her control)
- Franchisor has much more bargaining power than independent
- Franchisor controls exclusivity of rights (eg another store opening)
When valuing a franchise, what do you compare?
Compare cash flows from operating WITH brand name value, product/service/ expertise, and legal monopolies to operating WITHOUT those things.
What are 3 “firm wide cash flow generating intangible assets” characteristics?
- Difficult to isolate
- Company can charge higher prices for its products
- Examples are brand name and value of human capital
How to value “firm wide cash flow generating intangible assets” using Capital invested?
- Look at investments over time such as advertising or training costs
- Capitalize expenses over time
How to value “firm wide cash flow generating intangible assets” using DCF?
Use expected incremental cash flows, separating out cash flows that can be attributed to the asset
How to value “firm wide cash flow generating intangible assets” using Relative valuation?
Compare to similar companies without the intangible asset
How to value brand name using historical cost approach?
- Determine amortizable life based on how long benefits will accrue
- Collect brand name expenditure each year
- Write off a portion each year as amortization
- Sum unamortized expense
How to value brand name using DCF?
Compare the brand name company’s cashflow to a generic company’s cashflow to find the brand name value.
What is the “Generic operating margin approach” for valuing brand name?
Replace the operating margin of the brand name firm with the operating margin of generic company in same business.
What is the “Generic return on capital approach” for valuing brand name?
Replace the return on capital of the brand name company by the return on capital of a generic company
What is the “Generic excess return approach” for valuing brand name?
Replace the excess returns earned by the brand name company by the excess returns earned by the generic company.
What is the “Excess Return Model” for valuing brand name?
When a generic company doesn’t exist to compare to, the Excess return model is used. by assuming all excess value comes from brand name.
What is the “Excess Return Model” formula for valuing brand name?
Value of brand name = Estimated DCF value of firm - Capital invested in firm
What is the Relative Valuation Approach formula for valuing brand name?
Brand name value = ( (EV / Variable)_Brand Name - (EV /Variable)_Generic ) * Variable_Brand Name
What 2 things affect the value of goodwill?
- Mismeasurement of book value
2. Overpayment or underpayment on acquisition
What is good will mismeasurement of book value?
If the book value of assets is understated because of accounting choices, the value of good will be overstated, and if the book value is overstated, good will be understated.
What is good will overpayment or underpayment on acquisition?
The acquiring company over pays on an acquisition, its goodwill will increase by the overpayment. If it underpays, the reverse will occur.
What are 2 intangible assets with potential future cash flow?
- Undeveloped patents
2. Natural resource options
What are undeveloped patents?
A patent provides a firm with the right to develop and market a product or service and thus can be viewed as an option.
While an undeveloped patent may not be financially viable today, it can have value in the future.
What are natural resource options?
Natural resource companies, such as oil and mining companies, generate cash flow from their existing reserves but also have undeveloped reserves that they can develop if the choose to do so.
