Valuation of Intellectual Property
IPSI - 1998

Final Examination - 1 hour

This is a closed-book, no notes examination. You may use a calculator and scratch sheets when necessary. Students for whom English is a second language may also use a language dictionary.

The examination comprises: 15 multiple choice questions (4 points each) 60 points
10 true / false questions (2 points each) 20 points
2 short answer questions (10 points each) 20 points
Total points 100


Mark your answers on these pages. Only these pages will be graded.










15 Multiple Choice Questions - There may be more than one correct answer for each question. Circle the letter associated with the correct answers. Be sure you mark all of the correct answers.

1. Which of the following are reasons why a valuation of intellectual property may be undertaken? a. To allocate the purchase price for the acquisition of a company. b. To establish the amount of damages in an infringement litigation. c. To restate the amounts on the balance sheet of a U.S. company to current value. d. To assist the buyer or seller in a potential transaction.


2. Monetary assets are defined as:

a. Cash and-cash equivalents
b. Current assets less current liabilities
c. Assets less liabilities
d. Net working capital


3. In what asset classification does "machinery and equipment" belong?

a. Monetary assets
b. Intangible assets
c. Tangible assets
d. Plant, property & equipment


4. In the annual report of a publicly-traded company we read that estimates were made of the economic remaining life of the company's fixed assets. Who prepared these estimates?

a. Company management
b. The company's outside auditors
c. Company engineering staff
d. Tax authorities


5. In a consulting assignment for FPLC, Inc., we learn that the company has entered into a long- term agreement with another company which will distribute FPLC's products throughout the world. What type of asset would you consider this to be?

a. Monetary asset
b. Intangible asset
c. Intellectual property
d. Relationship


6. What would you consider in order to conclude whether this asset had value in the FPLC enterprise?


a. The geographical coverage of the agreement
b. The cost of these services compared to the market price for similar services
c. The length of time the agreement will be in effect.
d. The reputation of the company that will provide these distribution services.


7. In a patent infringement litigation, FPLC, Inc. has successfully argued that its patent No. 5,667,312 for a chemical process is valid and has been infringed by defendant, Slickco, Corp. During the period of infringement, FPLCs profits on products produced by the patented process were $123 million lower than the previous year. Other chemical companies also suffered lower profits during this period, due to poor economic conditions. Slickco profits from the infringing products were $41 million, calculated on an incremental basis. What damage estimate is the Court most likely to accept?


a. $123 million
b. $123 million plus $41 million = $164 million
c. $41 million
d. Slickco profits calculated on a fully-absorbed basis


8. In a trademark infringement, damages may be quantified by:

a. Plaintiffs lost profits
b. Defendant's profits on sales of the infringing goods
c. The cost to remedy the public confusion caused by the infringement
d. A reasonable royalty


9, FPLC, Inc. wishes to enter into a license with Trueco Co. in which FPLC will grant Trueco the non-exclusive right to use its commercially untested, but promising patented chemical process technology in return for the payment of a royalty. The development of this technology has been a long and expensive process for the scientists at FPLC, but in the laboratory the new process reduces the amount of electric power required in the manufacture of certain chemicals. You have been asked by FPLC to advise on this transaction. What would you advise FPLC to accept as the royalty base?

a. The number of tons of chemical product that Trueco will produce using the technology
b. The sales revenue collected by Trueco for products produced by the technology
c. The savings in the cost of electricity used in the manufacture of products using the technology
d. The net income of Trueco, on the sales of products made using the technology and other products sold as a result


10. What are typical characteristics of intangible assets?

a. They require a lower rate of return than other assets
b. They are more liquid than other assets
c. Investing in them carries more risk ,
d. They are more valuable than other assets


11. What information is useful in quantifying the plaintiff s lost profits in a patent infringement case?

a. Number of units of product sold.
b. The "Georgia-Pacific 15" factors.
c. Price changes.
d. Advertising and marketing expense.


12. In order to employ a market approach in valuing an intangible asset, we need to use data from:

a. The sales of comparable property
b. Property transactions between related parties
c. Transactions that took place on or near the appraisal date
d. Transactions that only involved the exchange of cash


13. Managers of a public company are interested in maintaining a high price for the stock of their company because:

a. It enhances their balance sheet
b. It improves their ability to obtain new capital
c. It lowers the price-earnings ratio to a more rational level
d. They can make more acquisitions


14. Functional obsolescence is a measure of:

a. The effect of economic conditions on the value of an asset
b. Whether an asset performs in "state-of-the-art" fashion
c. The extent to which an asset is worn or deteriorated
d. The extent to which an asset is as productive as a new asset


15. Attached is a page which provides an income statement and balance sheet for FPLC, Inc. for the years 1996 and 1997. From the data contained thereon, which of the following is true?

a. FPLC earnings per share at December 1997 was $3.16
b. FPLC price / earnings ratio at December 1997 was 28 times
c. FPLC capital structure at December 1997 was 32.3% long-term debt and 67.7% stockholders' equity.
d. During 1997, FPLC required $.41 in tangible assets for each $1.00 of sales revenue.





10 True/ False Questions. Circle the "T" or "F" after each question.

1. A company's balance sheet informs us about financial transactions only during the most recent accounting period. T F

2. The economic considerations in a licensing transaction are usually governed by the economics of the licensor's business. T

3. A discounted cash flow analysis calculates the relationship between the price of a company's stock and its most recent earnings per share. T F

4. In selecting an expert witness to prepare valuation testimony, you should seek a person who will be an effective advocate for your client, T F

5. Accounting depreciation allocates cost over several accounting periods and amortization does the same. T F

6. The income approach requires an estimate of functional obsolescence. T F

8. In the "relief from royalty" technique, we use a royalty amount as a surrogate for the income attributable to an intangible asset. T F

9. The value of a company's tangible assets will increase, without limit, as the company's profits increase. T F

10. "Net book value" can be defined as the present value of the future benefits of ownership. T F




Short Answer Questions. Write your answer in the space provided. Since space is limited, plan your answer before you write.

1. FPLC, Inc has asked you to advise on what royalty rate it shouId negotiate for in the transaction which is described in multiple choice question # 9. You have made a discounted cash flow analysis with the following result:

1 . The fair market value of the Trueco business without the technology is $852 million.
2. If Trueco employs the FPLC technology, the value of its business would be $1,052 million.
3. You insert a 5% royalty rate into the DCF analysis and the indicated value of the Trueco, business becomes $850 million.


What would you advise FPL C as to a reasonable royalty rate on which to begin negotiations, and what are the reasons for your opinion?




2. The management of FPLC, Inc. has been advised by its accounting firm that it should establish a holding company which would own its intangible assets and intellectual property. The auditors have told management that this would save taxes and improve FPLC's management and exploitation of its intangible assets.

Management is concerned about the cost of establishing a holding company and questions whether its intangible assets are worth the time and expenditure. Some managers feel that FPLC should continue to concentrate on maximizing the productivity of its plant property and equipment as they have always done.

You have been asked to provide your opinion to assist management in making this decision. What is your advice?






FINANCIAL DATA - FPLC, Inc.

FPLC, Inc
Income Statement
($millions)

Years ended June 30,

1997
1996
Net Sales $11,921 $11,761
Cost of Products Sold 6,772 6,921
Gross Margin
5,149


4,841

Marketing, Research, Admin. Expenses 3,320 3,236
Operating Income
1,829


1,605

Interest Expense 152 161
Other Income, net 73 113
Earnings before Income Taxes
1,750

1,556
Income Taxes 611 541
Net Earnings
$1,138


$1,015

Average Common Shares Outstanding (mill) 360.3 360.3
December 31 price ($ per share) $83.50 $68.75




FINANCIAL DATA - FPLC, Inc.
(CONTINUED)

Balance Sheets
($millions)

Years ended June 30, 1997
1996
ASSETS
Current Assets$ $
Cash 783 691
Investments 253 149
Accounts Receivable 913 947
Inventories
Materials and Supplies 377418
Work in Process 76 70
Finished Goods 576555
Deferred Income Taxes 220199
Prepaid Expenses 397
573
Total Current Assets3,5953,602
Property, Plant, and Equipment
Buildings 1,136 1,123
Machinery and Equipment 4,882 4,725
Land 190
190
6,208 6,037
Less Accumulated Depreciation2,416
2,331
Total Property, Plant, and Equipment3,792 3,706
Goodwill and Other Intangible Assets
Goodwill 1,3051,392
Less Accumulated Amortization350
330
Total Goodwill and Other Intangible Assets955
1,062
Total Assets $ 8,342 $ 8,370
LIABILITIES and SHAREHOLDERS'
EQUITY
Current Liabilities
Accounts Payable734745
Accrued Liabilities1,4161,555
Taxes Payable315164
Debt due within one year283
372
Total Current Liabilities2,7482,836
Long-Term Debt1,381
1,557
Total Liabilities4,1294,393
Shareholders' Equity
Common Stock450457
Paid-in Capital18698
Retained Earnings3,577
3,422
Total Shareholders' Equity4,213
3,977
Total Liabilities and Shareholders'Equity$ 8,342
$ 8,370