FITT Toolbox: Cost Approach


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The Cost Approach case develops the example of a trended historical cost approach to valuation for a pool of patents. It is based on tangible experience incoming from TUDOR technology transfer activities. Although historical cost approaches to valuation are often presented as the simplest of all quantitative valuation methods, the reader will understand some drawbacks and key elements in order to ensure a valid valuation in such a framework.

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FITT Toolbox: Cost Approach

  1. 1. Cost Approach FITT– Fostering Interregional Exchange in ICT Technology Transfer – www.FITT-for-Innovation.euExcept where otherwise noted, this work is licensed under a Creative Commons Attribution 3.0 License.
  2. 2. Case - In brief 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 example2 | April 2011 Cost Approach
  3. 3. Valuation - A question of Time Cost Approach Image source : Microsoft Office 2007 Cliparts Past Present Future Time Market Approach Income Approach Valuation case hereby developped is based on the cost approach3 | April 2011 Cost Approach
  4. 4. Case exposed Introduction to cost approaches TRENDED HISTORICAL COSTS METHOD IDEA : Measure the actual (trended) costs incurred during the creation and Image source : Microsoft Office 2007 Cliparts 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.4 | April 2011 Cost Approach
  5. 5. 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 Image source : Microsoft Office 2007 Cliparts  Answer a simple question : « how much did this invention cost us? »5 | April 2011 Cost Approach
  6. 6. Case exposed 6 steps procedure6 | April 2011 Cost Approach
  7. 7. Step 1 ~ IP asset description Description of IP asset under valuation • Patent familly composed of a set of patents in the healthcare sector7 | April 2011 Cost Approach
  8. 8. Step 2 ~ Identification of information sources Information sources Image source : Microsoft Office 2007 Cliparts • Accounting balance sheets • Research reports • Project follow-up reports Usually the best • Direct interviews with all stakeholders source of information8 | April 2011 Cost Approach
  9. 9. Step 3 ~ Selection of data 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)9 | April 2011 Cost Approach
  10. 10. Step 4 ~ Costs Compilation 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 All expenditures are validated by team from outside services mainly for patenting procedures. (goal is to exclude non valid ones)10 | April 2011 Cost Approach
  11. 11. Step 5 ~ Cost trend factors application Yesterday’s value ≠ Today’s value Impact of inflation  Use of Consumption price index 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 offices11 | April 2011 Cost Approach
  12. 12. Step 6 ~ Depreciation  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.12 | April 2011 Cost Approach
  13. 13. Conclusion • 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 approaches13 | April 2011 Cost Approach