The Cross-Border Biotech Blog

Biotechnology, Health and Business in Canada, the United States and Worldwide

Valuation and other Biotech Mysteries Part 2: Some Basic Mathematics

[Please note that this blog series has not been pre-written. The subject of the next post in the series will be determined by where the current post leaves off and any questions that readers send me or leave as comments on the posts.]

When you create a valuation spreadsheet, you are plugging in numbers representing revenues and expenses which are going to occur over several years. When you do the basic addition and subtraction in this spreadsheet, you hopefully end up with a positive number because, if the number is negative, you are valuing something that is not economically viable.

However, we all know that a dollar received now is worth more than a dollar received ten years from now. This is extremely relevant for a biotech company because most expenses occur before any of the revenues. You need to adjust all future revenues and expenses so they are calculated in current dollars and the sum is called the ‘net present value’ or NPV. The key factor in this calculation is the discount rate or ‘risk-free cost of capital’. At this time, I would use a discount rate of 8% in doing an NPV analysis. You can get more detailed information from statistics textbooks or entering NPV in your web browser or spreadsheet help function.

While we all generally accept that a current dollar is worth more than a future dollar, you actually have to do the calculation to see the impact of time on the value of your money. The table below shows the NPV of a guaranteed $100 payment received now or from one to ten years from now, using discount rates of 8% and 20%.

Year

Discount Rate

 

8%

20%

Now

$100.00

$100.00

1

$92.59

$83.33

2

$85.73

$69.44

3

$79.38

$57.87

4

$73.50

$48.23

5

$68.06

$40.19

6

$63.02

$33.49

7

$58.35

$27.91

8

$54.03

$23.26

9

$50.02

$19.38

10

$46.32

$16.15

I used the term ‘risk-free’ above because it does not take into account the risks associated with biotech, which can be large and numerous. There is a continuous need to understand and balance the risks and potential rewards. In the next few parts of this series, we will continue looking at valuation of the potential rewards before we move onto looking at the risk side of the equation.

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