Question

1. What is the economic advantage to a trade secret? Please explain why. 2. Of the three valuation methods for an intangible asset discussed in the chapter, which one would you use and why? 3. Regarding Stock Price, explain how it is set at the time of company formation. Describe the key factors that influence stock price before IPO 4. Regarding Stock Price, explain what dominates stock price after IPO. 5. How are the changes in the market price of a stock reflected in the Balance Sheet?

Answer 1

Part (1)

The economic advantages of trade secrets are:

• Superior benefits / advantage to the owner of the trade secrets
• Others are not aware of the secret, hence it gives competitive edge to the company with trade secrets
• Unlimited expiry: there is no limit on how long the trade secrets are to be kept secret. Potentially, it can be kept secret all throughout and doesn't have any expiry time like patent. Hence, the trade secrets can provide benefits perpetually.
• Registration is not required. Hence, costs associated with registration can be eliminated.
• No disclosure is required. Hence, disclosure costs can be avoided.
• Immediate benefits: since there is no requirement for registration and disclosure, benefits can start flowing in to the company almost immediately.

Part (2)

Of the three methods discussed, I will follow the income approach. It primarily resides on the principal of valuation that value of an asset should be nothing but present value of the future income (cash flows) it can generate. The method has its own challenges but among the options available, this method is best suitable to get the market valuation of intangible assets.

Part (3)

At the time of company formation, the price of the company is usually the face value or par value of the share itself. The value can be set as $ 1, $ 0.1, 0.01 or even 0.0001.

When the company hits the capital markets at the time of IPO, it's price is determined by investment banks on the basis of past and future projected performance.

Determinants of price before IPO

• Future projected performance
• Revenue driver & cost drivers
• Macro economic condition
• Product differentiation
• Management and promoters' quality
• Organizational development
• Growth potential
• Risk profile

Part (4)

Determinants of price after IPO

• Sustainability of growth
• New products, new businesses, new segments - growth
• Quality of earnings
  • Maturity of cash flows
  • Growth in earnings
  • Stability
  • Sustainability
• Competitive advantage

Part (5)

The shares are captured at book price on the balance sheet. Market price or price in the secondary market has no impact on the way shares are captured on balance sheet. Hence, change in market prices are not reported on the balance sheet of the company.