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Cost Approach

FITT

(Fostering Interregional Exchange in ICT Technology Transfer)

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This case is based on a valuation example

• Valuation method is a trended historical cost-based approach

• Case exposes the various steps needed to be followed in order to succeed such a valuation

• Case is based on a real-world example

Case - In brief

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Valuation - A question of Time

PresentPast Future Time

Cost ApproachCost Approach

Market Approach Income Approach

Valuation case hereby developped is based on the cost approach

Image source : Microsoft Office 2007 Cliparts

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Case exposedIntroduction to cost approaches

TRENDED HISTORICAL COSTS

METHOD

IDEA : Measure the actual (trended) costs

incurred during the creation and

development of the IP.

REPLACEMENT COSTS METHOD

IDEA : Use an estimation of the costs to

obtain an equivalent IP asset with similar

use or function (economic utility) as the

original IP asset under valuation.

REPRODUCTION COSTS METHOD

IDEA : Based on the costs to purchase or

create an exact replica of the IP asset

subject to valuation.

Image source : Microsoft Office 2007 Cliparts

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Case exposed (introduction)

In this Case, we used the trended historical cost method

Advantages

Simple method

Accounting information was available

Information was available

Valuated IP asset was clearly identified

Team was available

Answer a simple question : « how much did this invention cost us? »

Image source : Microsoft Office 2007 Cliparts

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Case exposed

6 steps procedure

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Description of IP asset under valuation

• Patent familly composed of a set of patents in the healthcare sector

Step 1 ~ IP asset description

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Information sources

• Accounting balance sheets

• Research reports

• Project follow-up reports

• Direct interviews with all stakeholders

Step 2 ~ Identification of information sources

Usually the best

source of information

Image source : Microsoft Office 2007 Cliparts

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Used Data includes

• Cost of human resources (scientists, engineers, ...)

• Cost of IP asset protection

• Overhead costs for utilities and research space, for administrative and technical support

• Raw materials used

• Prototype construction and testing expenses

• Outside services for independent evaluation, certifications, patenting procedures

• Pilot plant expenses

• Sector specific administrative costs (i.e. approval procedure phase to commercialize a medical product, official recognition)

Step 3 ~ Selection of data

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Domains of expenditures are regrouped

• Human resources expenditures: e.g. salaries,

• R&D expenditures: e.g. plant expenses, raw materials (used for the prototype) expenditures, overhead costs,

• Juridical and administrative expenditures: expenditures from outside services mainly for patenting procedures.

Step 4 ~ Costs Compilation

All expenditures are validated by team

(goal is to exclude non valid ones)

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Yesterday’s value ≠ Today’s value

Impact of inflation Use of Consumption price index

Step 5 ~ Cost trend factors application

2003 2004 2005 2006 2007 2008

Consumption Price Index 2,00% 2,20% 2,50% 2,70% 2,30% 3,40%

Cost Trend Factor 1,16 1,14 1,11 1,09 1,06 1,00

To give an example of calculation, the cost trend factor for 2006 (in 2008 value) is equal to 1.09 = (1+2.7%)x(1+2.3%)x(1+3.4%)

Source of data : national statistic offices

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Depreciation which should be taken care of

• Physical depreciation: Physical wear and tear of the asset that makes it increasingly unable to perform with the speed, dependability and accuracy of a new counterpart. This type of obsolescence is rarely observed to the IP assets.

• Functional obsolescence: Over time, the IP asset may be less able to realise the specific function for which it was originally developed.

• Technological obsolescence: Often considered as a subset of the functional obsolescence it is linked to a change of the state of art, the development of new technologies that make the technology of the IP asset not useful anymore.

• Economic obsolescence: Economic conditions that reduce consumer demand and yield excess industry capacity.

Step 6 ~ Depreciation

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• Trended historical cost approach is a fairly easy valuation method, mostly based on available data

• Calculation of trend factors and depreciation can be difficult, dependng on the IP under valuation

Such an approach constitutes an important initial source of information, but depending on the reason for the valuation action, it most oftenly needs to be completed with market and/or income approaches

Conclusion