Valuation of Intellectual Property

IPSI - 1999

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) 2Q 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. Tangible assets are defined as:

a. Plant property and equipment
b. Current assets less current liabilities
c. Fixed assets
d. Original cost less accrued depreciation

2. Net working capital is equivalent to:

a. Monetary assets
b. Current assets less current liabilities
c. Cash plus inventory
d. Current assets less accounts payable

3. Which of the following are reasons why a valuation of intellectual property may be undertaken?

a. To allocate the purchase price after an acquisition of a company
b. To establish the basis for the payment of estate taxes
c. To establish the amount of damages in an infringement litigation.
d. To assist a trustee in bankruptcy to properly dispose assets

4. The single, most important factor in the valuation of intangible assets or intellectual property lies in discovering:

a. How it is protected                                                                                                                                                     b. The economic benefit it provides
c. How its development was financed
d. The profitability of the company using it

5. You have been retained to express an opinion of the value of the intangible assets of FPLC, Inc. Your investigation reveals extensive software developed by FPLC to manage its customer database. What valuation method are you most likely to employ to appraise this software?

a. Market approach
b. Cost approach
c. Income approach
d. Principle of substitution

6. The 1998 balance sheet f or FPLC, Inc, shows an amount for "Goodwill" of $ 955 million. What does this represent?

a. The current value of FPLC intangible assets                                                                                          
b. A portion of the purchase price in previous acquisitions
c. The amortized cost of self-developed intangible assets
d. The difference between FPLC's market value and the value of its tangible assets

7. In 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, FPLC's 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. What damage estimates are likely to be considered in the damages decision?
 

a. $123 million
b. The cost of remediating damages suffered by FPLC
c. $41 million
d. A reasonable royalty on Slickco's sales of the infringing product

8. You are retained by FPLC, Inc to express an opinion on the value of its trademark portfolio. What valuation technique are you most likely to use?

a. A capitalization of the income attributable to the marks
b. The estimated cost of reproduction of the marks
c. A calculation based on the sale of similar marks
d. An estimate based on the net book value of the marks

9. FPLC, Inc. wishes to enter into a license with Trueco Co. in which FPLQ, will grant Trueco the right to use its commercially untested patented chemical process technology. The new process, if commercially successful, will reduce the amount of electric power required in the manufacture of certain chemicals. You have been asked by FPLC to advise on this transaction. What royalty base is clearly not acceptable to FPLC in a license?
 

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

10. What are typical characteristics of intangible assets?

a. They require a lower rate of return than most other assets
b. They are more versatile than other assets
c. Investing in them carries more risk
d. They can be developed using debt capital

11. You have been offered the right to receive $1,000 in a lump sum on December 31,2003, guaranteed by a major bank, but the terms are negotiable. Which of the following changes in the terms would reduce the amount you would be willing to pay today for this right?

a. You would receive the $1,000 in monthly payments
b. The bank guarantee is removed
c. Payment will be made in Deutschmarks at the current exchange rate
d. You would receive $1,025 at June 30,2003

12. In order to employ a market approach in valuing an intangible asset as part of a going concern, we should use data from:

a. The sales of comparable property
b. Property transactions between related parties
c. Transactions that involved an orderly liquidation
d. Transactions that only involved the exchange of cash

13. The value of a business enterprise can be estimated by:
a. Adding together long-term debt and stockholders' equity from the
balance sheet.
b. Adding together the values of monetary, tangible and intangible
assets.
c. Adding together the values of long-term debt and stockholders' equity.
d. Multiplying the common stock price by the number of shares.

14. Economic 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 will be able to provide a reasonable return on investment to its owner.

15. Attached are pages which provide an income statement and balance sheet for FPLC, Inc. for the years 1997 and 1998. From the data contained thereon, which of the following is true?

a. FPLC earnings per share at December 1998 was $3.16
b. The value of FPLC stockholders' equity at December 31, 1997 was $3,977 million
c. FPLC net working capital at December 1998 was $6,343 million
d. The net book value of FPLC tangible assets at December 31, 1998 was $3,792 million
 

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

1. A company's income statement informs us about financial transactions during only one accounting period (typically one year). T F

2. A discounted cash flow analysis calculates the relationship between the price of a company's stock and the cumulative dividends received. T F

3. It is safe to assume that the financial statements of a publicly-traded French company are prepared according to GAAP. T F

4. The income approach requires an estimate of physical deterioration. T F

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

6. The value of a company's intangible assets can be estimated from the balance sheet. T F

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

8. The economic considerations that control a licensing transaction are usually those that reflect the profitability of the licensor's business. T F

9. Intangible assets represent a highly liquid investment. T F

10. Changes in share prices in the stock market produce corresponding changes in a public company's balance sheet. T F
 

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

1. FPLC management has asked your opinion about the royalty rate which will be the likely outcome of the licensing negotiations described in question 9. You have performed a discounted cash flow analysis with the following result:

     1. Your calculations indicate that the fair market value of the Trueco business without the technology is $852 million.

     2. When you reflect the estimated benefit of the FPLC technology, the value of the Trueco business would be  $1,052 million.

      3. When you insert a 5% royalty rate into the DCF analysis the indicated value of the Trueco business becomes $850 million.

The reason why FPLC wishes to license this technology is that its engineers have advised that a very large investment will be required to commercialize it, and management's decision has been to invest those resources in another project.

What is your opinion, and what are the reasons for it?

2. The manager of R&D for your client, Semiconductors, Inc., has developed an innovative manufacturing technique that could significantly improve manufacturing throughput of a new generation chip that is nearing commercial production. She is eager to patent this potentially profit-enhancing innovation, even though patent prosecution is likely to be difficult. A business decision must be made whether to allocate resources to obtain this patent.

How do you advise this client, and what are your reasons?



FINANCIAL DATA - FPLC, Inc.


FPLC, Inc
Income Statement
$millions
Years ended June 30 1998 1997
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
ASSETS
Current Assets
   Cash $783 $691
   Investments 253 149
   Accounts Receivable 913 947
   Inventories
      Materials and Supplies 377 418
      Work in Process 76 70
      Finished Goods 576 555
 
      Deferred Income Taxes 220 199
      Pre-paid Expenses 397 573
------------ ---------
 Total Current Assets  3,595 3,602
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 Depreciation 2,416 2,331
------------ ---------
Total Property, Plant and Equipment 3,792 3,706
Goodwill and Other Intangible Assets
   Goodwill  1,305 1,392
   Less Accumulated Amortization 350 330
------------ ---------
Total Goodwill and Other Intangible Assets 955 1,062
------------ ---------
TOTAL ASSETS $ 8,342 $8,370
LIABILITIES and SHAREHOLDERS EQUITY
Current Liabilities
    Accounts Payable $ 734 $ 745
    Accrued Liabilities 1,416 1,555
    Taxes Payable 315 164
     Debt Due within one year 283 372
------------ ---------
Total Current Liabilities 2,748 2,836
Long Term Debt 1,381 1,557
Total Liabilities 4,129 4,393
Shareholders Equity
   Common Stock 450 457
   Paid-in Capital 186 98
   Retained Earnings 3,577 3,422
------------ ---------
Total Shareholders' Equity 4,213 3,977

 

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