Hi, I'm Christine Siu
and I'm going to walk you through the second
half of the presentation today.
My background is twelve years
in venture capital and private equities,
specializing in biotech and life
science companies.
I spent the last four years advising
and building companies in biotech.
So Jeshaune would've walked you through
revenue and costs, and forecasting,
and we're going to go through the cost of capital
section next.
So the cost of capital is
how to evaluate and prioritize
projects, how projects will be assessed
financially, and how to compare projects financially.
The cost of capital is the rate of return
required to persuade an investor
to make a given investment.
So for example, Biotech XYZ wants to raise
equity to fund a clinical trial of its lead drug.
Equity investors would require a 30%
rate of return to make the investment.
Therefore, the company's cost of capital,
for the equity, is 30%.
The cost of capital is dependent
upon the perceived risk of the company
or the investment. The less risky an investment is,
the lower the cost of capital would be.
How this translates in drug development
is seen here, so basically, you've got
thousands of compounds at very early stages.
And those are worked through the funnel
of clinical development until
hopefully you have at least one
successful compound approved by the FDA
at the end.
As the drug is working its way through
the clinical development cycles,
it's being de-risked and the probability of success is going up.
The cost of capital is going down
as a probability of success increases,
so therefore, they are indirectly proportional
to each other.
The opportunity cost is the cost of
the next best alternative that must be
foregone in order to choose a desired plan.
Opportunity cost is all about tradeoffs.
So in a very simplistic example,
if there's an apple and an orange,
if you choose the apple, the opportunity cost
is the orange. And perhaps a more relevant
example, if I decide to attend graduate school,
the opportunity cost of going to graduate school
is the value of the foregone wages had I worked instead.
Investors have multiple options
to invest their capital and will demand
a higher return, i.e. a higher cost of capital,
to invest in riskier companies.
In this example, which company
would have the higher cost of capital?
Biotech A has a drug candidate that is
in preclinical testing and needs to raise
money to file an IND.
Biotech Z has a drug candidate in a phase 3
clinical study and needs to raise money to file an NDA.
In this example, Biotech A has the higher cost of capital.
Its drug is in earlier stages and it's riskier.
So NPV is the Net Present Value.
This concept relies on the time value
of money, it's the fundamental principle
in finance that a dollar today is worth more
than a dollar in the future.
So the NPV translates an investment's value
over time in today's dollars.
The equation to do this
is the future value equals the present value
times 1 plus the interest rate
to the nth power.
Where n is the number of periods,
usually years in this case.
So the important thing to note about
this equation is the interest compounds
on an annual basis, so this is not a linear
equation, this is an exponential function.
The Net Present Value is simply
the Summation of all the Present Values.
In this example, Biotech X is considering developing
a drug. It will cost $500,000,000 over 8 years
before the drug is approved.
Once approved, the drug will produce
$1,500,000,000 in profit over 2 years.
Should the biotech company invest in this drug?
So here you see all the annual cash flows laid out
from year 1 to 10, those are the future values.
You'll see the discount we've selected here is 25%
and using the previous equation, you'll see that we discounted
them to the present value today.
You'll see the concept of time value money
at work here if you look out in year 10,
you'll see that $107,000,000 is worth quite
a bit less than the billion dollars in year 10 future value.
So, the net present value
is the summation of all of those cash flows
in the present tense, and you'll see that
that equals 32.
So what does that 32 mean?
Well, it means that the NPV is positive,
and the investment would earn money for the biotech company.
So the NPV is an indicator
of how valuable a project can be
and whether it's worth investing in.
So if the NPV is greater than 0,
it means the investment would add value to the firm.
If the NPV is less than 0,
it means it would subtract value from the firm.
If it's 0, it's neither a gain or a loss.
So the IRR, the Internal Rate of Return,
is the interest rate at which the net present
value of all the cash flows equals zero.
So if you're looking at the mathematical equation,
this is basically setting the NPV equal to 0,
and solving for the interest rate at which that happens.
The practical use is the IRR can be
used to evaluate the attractiveness
of a project or an investment.
If the IRR of a new project exceeds a company's
required rate of return, that project is desirable.
If the IRR falls below the required
rate of return, the project should be rejected.
In this example, a venture capitalist
is considering an investment in a biotech company
developing a drug for Alzheimer's.
The company would require a $10,000,000 investment
today and another $20,000,000 investment
in two years. The VC expects to sell the shares
for $90,000,000 five years from today.
The VC's hurdle rate is 25% for biotech investments.
Should they make the investment?
So here again, we've laid out the cash flows,
you see the $10million that would need to be
invested today, the $20million invested two
years from today, and the $90million in return
five years from today.
The IRR at which the NPV would equal
0 is 33.5%. And what does that mean?
Well, the 33.5% is greater than the VC's hurdle
rate, so that means that they should
make this investment.
So, in summary, the cost of capital
is used by all organizations
when assessing the cost of funding operations.
The NPV is used mainly by companies
when valuing assets to acquire.
They can also be used by equity research analysts
when valuing companies and their future cash flows.
The IRR is used mainly by investors when
evaluating an investment opportunity.
Here are some advanced topics to look into,
for example, you could look into
the discount rate and how that's calculated,
there's also a lot of mathematical equations
and variables behind that.
So here are a few scenarios to consider,
in terms of parallels to academia,
I would strongly encourage you to view Amy's
presentation, she will talk about examples about
opportunity costs in a lab, she'll walk
through NPV and how she's decided on which
projects to invest in, in her experience.
So for finance course objectives,
by now you should be able to identify the three
different financial statements and how
scientists use them. Read and understand a P&L
statement. Calculate burn rate.
Explain and apply concepts
such as opportunity cost, cost of capital,
and NPV. And apply these concepts in financial planning.
Thank you for watching our presentations.