There has been considerable amount of debate on what discount rates should be used in each and every phases of a biotech project. Should you use the cost of capital of the company while evaluating projects?

The answer is clearly ‘NO’. The cost of capital could only be the same for both project and the company provided the company is just in one business and the investments in all the projects are homogenous.

What if the company is involved in three avenues of business? Should you use the same discount rates for all the three? Please note that the risks of all the three avenues might be different which would demand a different Beta. Besides, if the project is executed in emerging/riskier markets, it demands a separate country risk premium to be added, which further increases the discount rate.

This will be also true for companies willing to enter a new investment. The cost of equity should be calculated based on the riskiness of the new investment and the cost of debt and debt ratios should be calculated based on debt ratios of other firms in the same business.

Whose cost of capital should you use when you outlicense your product to another firm? Or whose cost of capital you use if you co-develop a project with another company?

We look at these answers in our next view post. Stay tuned

–          Saurabh Mishra