Aqua Bounty Case

Fall
2020
FMB513E Advance Corporate Finance
Corporate Finance Assignment 1

AquaBounty Case
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[Executive Summary]
AquaBounty is a biotechnology company that has developed ways to genetically modify salmon and trout to grow
into full size much faster than conventional fish. Although there could be both economic and environmental
benefits from their development of this product, this project was full of uncertainty. AquaBounty had to go
through the rigorous process of regulatory approval from the FDA, which was assumed to take around 3 years.
Also, there were uncertainties regarding the future sales and payment of expenses. In order to diversify their
sales, AquaBounty jumped into shrimp aquaculture business by developing Shrimp IMS to boost shrimp’s
immune system, designing VPX to prevent shrimp from developing white spot syndrome virus, and developing
diagnostic kit to test for common diseases in shrimps. AquaBounty is planning an IPO in the UK AIM as it is
expected to require significant costs related to regulatory approval and commercialization in the future.
Our team concluded that AquaBounty's IPO in the UK AIM was a reasonable choice due to high awareness of
aquaculture in the European market, lack of current reserves, and the valuation of AquaBounty at £58.76 based
on the black shoeless model or at £61.95 based on the decision tree as of the end of 2005.
1) What are the principal sources of uncertainty facing AquaBounty? Why did it diversity?
AquaBounty successfully developed a genetically modified strain of salmon and trout, which could significantly
reduce the time for fish to fully grow. However, since the idea of genetically modified fish itself is a new concept in
this world, questions regarding safety of our product arose. Also, some sensitive environmental activists could oppose
this concept of genetic modification as it could be viewed ‘unethical’
The biggest risk AquaBounty faces is the indefinite time waiting for approval from the FDA for commercialization
due to these safety and ethical concerns. If not approved, our investment and time will be wasted. Furthermore, future
benefits could be reduced from strict regulation or specific requirements in managing genetically modified fish even
after approval is obtained.
AquaBounty is preparing for the IPO to seek for additional investment to go through this regulatory approval and to
continue development. However, AquaBounty also faces an investment risk because it is a relatively small company
that could be unfamiliar to investors.
Due to these uncertainties, AquaBounty is continuously seeking for additional aqua products that could provide some
diversification for its product line.
2) Does it make sense for the firm to launch an IPO now?
We believe that it makes sense to launch an IPO now because AquaBounty’s capital reserves is eroding and
additional investment is necessary due to long wait for regulatory approval. Even if we assume that FDA will surely
approve our product, AquaBounty still requires additional cash to pay for product commercialization costs for 3 years
following FDA approval.
AquaBounty had already conducted successful trial testing and as long as there is FDA approval, we believe that our
product will be immensely successful. Not only can FDA approval prove product stability, it can lead to significant
revenue generation in a rapidly growing market. Thus, the best way for AquaBounty to develop a major line of
enterprise products and raise significant capital for commercialization is the IPO, rather than seeking small funding
from individual investors of the entity for cash retention.
The risk of IPO could be AquaBounty’s inability to attract investors because of their small sized and for being a
start-up company. However, the European market is confident that AquaBounty could attract the necessary investment
because the European market has the knowledge and awareness with aquaculture industry.
3) Estimate the future free cash flows, gross of commercialization costs and FDA approval expenses, from
AquAdvantage fish under each of the “high”, “baseline”, and “low” scenarios for years 2006 through 2019.
Use the excel spreadsheet provided. Assume a corporate tax rate of 35%.
In order to estimate the future free cash flows for years 2006 to 2019 , we’ve estimated Revenues, COGS, SG&A,
product commercialization costs, FDA approval expenses, and income tax from 2006 to 2009 for 3 possible scenarios
(low, Baseline, and high). We assumed that under “low’ scenario, revenue would be 75% lower than under “baseline”
scenario, which would also be 75% lower than the “high” scenario. We estimated COGS by taking 20% of revenue
and estimated SG&A by making the “low” or “high” scenario differ from the “baseline” by 5% of the revenue
difference. To predict future income tax, we estimated NOLs(net operating loss) and once the company was free from
NOLs, we used 35% tax rate to calculate the income tax . By implementing the following equation, we calculated the
free cash flows for each scenarios.
FCF= Revenue –COGS- SG&A-Income Tax
Scenario 1 - Low 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Free Cash Flow 0.00 0.00 0.00 (3.76) (2.92) (1.56) 0.60 3.07 5.62 7.91 8.14 8.39 8.64 8.90
Scenario 2 - Baseline 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Free Cash Flow 0.00 0.00 0.00 (3.03) 0.32 5.75 14.41 24.26 32.75 28.36 29.21 30.08 30.99 31.92
Scenario 3 - High 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Free Cash Flow 0.00 0.00 0.00 (2.31) 3.56 13.06 28.21 39.60 41.17 51.57 53.12 54.71 56.36 58.05
4) Calculate the value of AquAdvantage (not including commercialization and FDA approval costs) at the
end of 2008 under each of the three scenarios. Assume an asset cost of capital ( ) of 14%. Assume also that
AquAdvantage’s free cash flows will grow at the rate of 3% after 2019.
We must use the FCF that we calculated in #1 to compute the present value of FCF. First, we must calculate the net
present value at end of year 2008, which came out to be £10.94M for low, £84.25M for baseline, and £150.55M for
high. Because, we assume the AquAdvantage’s free cash flow to grow at the rate of 3%, we implemented the
Gordon Growth Model in estimating the terminal value using the 14% cost of capital. After adjusting the terminal
value into the PV at the end of year 2008, we get the PV of terminal to be £19.72M for low, 70.71M for baseline, and
128.61M for high. To calculate the value of AquAdvantage at the end of 2008, we used the following equation
PV of FCFs(discounted 14% WACC of AquaBounty)= PV of Free Cash Flow + PV Terminal
Scenario 1 - Low 2005 2006 2007 2008

PV of FCFs (not include commercialization and FDA costs) 30.65
Scenario 2 - Baseline 2006 2007 2008

Scenario 3 - High 2006 2007 2008

5) Calculate the PV of commercialization costs discounted at f at the end of 2008. We will discount the
commercialization costs at the risk free rate because they are pretty well anticipated and are unlikely to be
affected by economic conditions.
During 2009 to 2011, substantial commercialization costs associated with this aqua-product were to occur(£12, 18,
15). We discounted those costs at rf(4.22%) to calculate the present value of commercialization costs.
PV of FDA commercialization costs 2005 2006 2007 2008 2009 2010 2011
PV (11.51) (16.57) (13.25)
Total PV of commercialization costs (at the end of 2008) (41.34)
6) Calculate the PV of FDA approval costs discounted at f today. We will discount the FDA approval expenses
at the risk free rate because they are pretty well anticipated and are unlikely to be affected by economic
conditions.
During 2006 to 2008, FDA approval expense of £2.5 are expected. We discounted those costs at rf(4.22%) to
calculate the present value of FDA approval costs .
PV of FDA commercialization costs 2005 2006 2007 2008
PV (2.40) (2.30) (2.21)
Total PV of FDA approval costs (today) (6.91)
7) Using your estimates of AquAdvantage value and commercialization costs in 2008, build a decision tree
incorporating regulatory and commercialization uncertainty. Assume that the firm will learn the true
scenario at the end of 2008.
Using the previously calculated PV of FCFs and PV of commercialization costs at the end of 2008, we calculated
NPV of the product for each scenarios. NPV of low scenario came out to be negative while other scenarios had
positive NPV. By taking the average of these 3 NPVs, the NPV of project at the end of 2008 was £113.59M. we
built a decision tree to view the NPV of each scenario.
8) Using the decision tree, price the option to commercialize AquAdvantage fish today, assuming that the firm
receives FDA approval.
Because AquaBounty will not take the project under the “low” scenario due to its negative NPV, we changed the NPV
of the negative value to 0 and recalculated the NPV at the end of 2008, which was £117.15M. The current value of
NPV at the end of 2005 was calculated to be £79.07M
9) You can also use a Black-Scholes model to value the option to commercialize AquAdvantage fish. Generate
inputs for the Black-Scholes model. Again, assume that the firm receives FDA approval.
To use a Black-Scholes model to value the option to commercialize AquAdvantage fish, it is necessary to generate
inputs. Stock Price at the end of 2005( ) was calculated to be £104.57M, Exercise price would be the same as the
inverse of commercialization costs at the end of 2008, which was £41.34M. Risk free rate of 10-year UK government
bond is 4.22% and the time to expiration would be 3 years (2005-2008). For volatility (σ), we looked at the similar
company “Devgen” and used their volatility of 4.2%
10) Suppose the Black-Scholes call option value from Q9 is £69.5M today. What is the fair firm value of
AquaBounty? Note that the estimated value of the shrimp therapeutics business is £35-50M.
First, we need to convert the current value (end of 2005) of £69.5M to £102.97M at the end of 2008 by compounding
annually for 3 years. Since there is 1/3 chance of FDA approval, the value of NPV at the end of 2008 becomes 1/3 of
£102.97M or in another words by taking the weighted average, which comes out to £34.32M. If we take that value
and convert it back to the current value to the end of 2005, we get £23.17M. Since the present value of the FDA
approval costs was £6.91M, the value of AquAdvantage Fish stocks would be £16.26M. After taking the value of the
shrimp therapeutics business, which is 35-50M, total value of AquaBounty will be between £51.26 to £66.26M.
Appendix
Question #3
Estimate the future free cash flow
Assumed Tax Rate 35%
Scenario 1 - Low 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Revenues 0.00 0.00 0.00 0.32 1.44 3.25 6.14 9.42 12.83 15.88 16.35 16.84 17.35 17.87
COGS 0.00 0.00 0.00 0.06 0.29 0.65 1.23 1.88 2.57 3.18 3.27 3.37 3.47 3.57
SG&A 0.00 0.00 0.00 4.02 4.07 4.16 4.31 4.47 4.64 4.79 4.94 5.09 5.24 5.40
Product commercialization costs 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
FDA approval expenses 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Income Tax 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Free Cash Flow 0.00 0.00 0.00 (3.76) (2.92) (1.56) 0.60 3.07 5.62 7.91 8.14 8.39 8.64 8.90
Income before Tax (2.50) (2.50) (2.50) (15.76) (20.92) (16.56) 0.60 3.07 5.62 7.91 8.14 8.39 8.64 8.90
NOLs (18.75) (21.25) (23.75) (26.25) (42.01) (62.93) (79.49) (78.89) (75.82) (70.21) (62.30) (54.16) (45.77) (37.13) (28.23)
Taxable Income(NOLs applied) (21.25) (23.75) (26.25) (42.01) (62.93) (79.49) (78.89) (75.82) (70.21) (62.30) (54.16) (45.77) (37.13) (28.23)
Income Tax 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Revenues 0.00 0.00 0.00 1.29 5.76 13.00 24.54 37.68 51.30 63.50 65.41 67.37 69.39 71.47
COGS 0.00 0.00 0.00 0.26 1.15 2.60 4.91 7.54 10.26 12.70 13.08 13.47 13.88 14.29
SG&A 0.00 0.00 0.00 4.06 4.29 4.65 5.23 5.88 6.57 7.18 7.39 7.61 7.84 8.08
Income Tax 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1.72 15.27 15.73 16.20 16.68 17.19
Free Cash Flow 0.00 0.00 0.00 (3.03) 0.32 5.75 14.41 24.26 32.75 28.36 29.21 30.08 30.99 31.92
NOLs (18.75) (21.25) (23.75) (26.25) (41.28) (58.96) (68.21) (53.81) (29.55) 0.00 0.00 0.00 0.00 0.00 0.00
Taxable Income(NOLs applied) (21.25) (23.75) (26.25) (41.28) (58.96) (68.21) (53.81) (29.55) 4.93 43.63 44.93 46.28 47.67 49.10
Income Tax 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1.72 15.27 15.73 16.20 16.68 17.19
Scenario 3 - High 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Revenues 0.00 0.00 0.00 2.26 10.08 22.75 42.95 65.94 89.78 111.13 114.46 117.89 121.43 125.07
COGS 0.00 0.00 0.00 0.45 2.02 4.55 8.59 13.19 17.96 22.23 22.89 23.58 24.29 25.01
SG&A 0.00 0.00 0.00 4.11 4.50 5.14 6.15 7.30 8.49 9.56 9.84 10.14 10.44 10.76
Income Tax 0.00 0.00 0.00 0.00 0.00 0.00 0.00 5.86 22.17 27.77 28.60 29.46 30.35 31.26
Free Cash Flow 0.00 0.00 0.00 (2.31) 3.56 13.06 28.21 39.60 41.17 51.57 53.12 54.71 56.36 58.05
NOLs (18.75) (21.25) (23.75) (26.25) (40.56) (55.00) (56.93) (28.73) 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Taxable Income(NOLs applied) (21.25) (23.75) (26.25) (40.56) (55.00) (56.93) (28.73) 16.73 63.33 79.34 81.72 84.18 86.70 89.30
Income Tax 0.00 0.00 0.00 0.00 0.00 0.00 0.00 5.86 22.17 27.77 28.60 29.46 30.35 31.26
Question #4
The value of AquAdvantage
Assumed Tax Rate 35%
Assumed WACC(Ra) 14%
Assumed Growth Rate 3%
Scenario 1 - Low 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Revenues 0.00 0.00 0.00 0.32 1.44 3.25 6.14 9.42 12.83 15.88 16.35 16.84 17.35 17.87
COGS 0.00 0.00 0.00 0.06 0.29 0.65 1.23 1.88 2.57 3.18 3.27 3.37 3.47 3.57
SG&A 0.00 0.00 0.00 4.02 4.07 4.16 4.31 4.47 4.64 4.79 4.94 5.09 5.24 5.40
Income Tax 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Free Cash Flow 0.00 0.00 0.00 (3.76) (2.92) (1.56) 0.60 3.07 5.62 7.91 8.14 8.39 8.64 8.90
NOLs (18.75) (21.25) (23.75) (26.25) (42.01) (62.93) (79.49) (78.89) (75.82) (70.21) (62.30) (54.16) (45.77) (37.13) (28.23)
Taxalbe Income(NOLs applied) (21.25) (23.75) (26.25) (42.01) (62.93) (79.49) (78.89) (75.82) (70.21) (62.30) (54.16) (45.77) (37.13) (28.23)
Income Tax 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
PV of Free Cash Flow 10.94
Terminal value 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 83.32
PV of Terminal 19.72
Revenues 0.00 0.00 0.00 1.29 5.76 13.00 24.54 37.68 51.30 63.50 65.41 67.37 69.39 71.47
COGS 0.00 0.00 0.00 0.26 1.15 2.60 4.91 7.54 10.26 12.70 13.08 13.47 13.88 14.29
SG&A 0.00 0.00 0.00 4.06 4.29 4.65 5.23 5.88 6.57 7.18 7.39 7.61 7.84 8.08
Income Tax 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1.72 15.27 15.73 16.20 16.68 17.19
Free Cash Flow 0.00 0.00 0.00 (3.03) 0.32 5.75 14.41 24.26 32.75 28.36 29.21 30.08 30.99 31.92
NOLs (18.75) (21.25) (23.75) (26.25) (41.28) (58.96) (68.21) (53.81) (29.55) 0.00 0.00 0.00 0.00 0.00 0.00
Taxalbe Income(NOLs applied) (21.25) (23.75) (26.25) (41.28) (58.96) (68.21) (53.81) (29.55) 4.93 43.63 44.93 46.28 47.67 49.10
Income Tax 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1.72 15.27 15.73 16.20 16.68 17.19
Terminal value 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 298.84
Scenario 3 - High 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Revenues 0.00 0.00 0.00 2.26 10.08 22.75 42.95 65.94 89.78 111.13 114.46 117.89 121.43 125.07
COGS 0.00 0.00 0.00 0.45 2.02 4.55 8.59 13.19 17.96 22.23 22.89 23.58 24.29 25.01
SG&A 0.00 0.00 0.00 4.11 4.50 5.14 6.15 7.30 8.49 9.56 9.84 10.14 10.44 10.76
Income Tax 0.00 0.00 0.00 0.00 0.00 0.00 0.00 5.86 22.17 27.77 28.60 29.46 30.35 31.26
Free Cash Flow 0.00 0.00 0.00 (2.31) 3.56 13.06 28.21 39.60 41.17 51.57 53.12 54.71 56.36 58.05
NOLs (18.75) (21.25) (23.75) (26.25) (40.56) (55.00) (56.93) (28.73) 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Taxalbe Income(NOLs applied) (21.25) (23.75) (26.25) (40.56) (55.00) (56.93) (28.73) 16.73 63.33 79.34 81.72 84.18 86.70 89.30
Income Tax 0.00 0.00 0.00 0.00 0.00 0.00 0.00 5.86 22.17 27.77 28.60 29.46 30.35 31.26
Terminal value 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 543.52
Question #5
Present Value of product commercialization
costs
Assumed Rf(10-year UK government bond) 4.22%
PV of FDA commercialization costs 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Product commercialization costs 0.00 0.00 0.00 (12.00) (18.00) (15.00) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
1/(1+Rf)^n 0.96 0.92 0.88 0.85 0.81 0.78 0.75 0.72 0.69 0.66 0.63 Rf 4.22%
PV (11.51) (16.57) (13.25)
Total PV of commercialization costs (at the end of 2008) (41.34)
Question #6
Present Value of FDA approval costs
Assumed Rf(10-year UK government bond) 4.22%
PV of FDA commercialization costs 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
FDA approval expenses (2.50) (2.50) (2.50) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
1/(1+Rf)^n 0.96 0.92 0.88 0.85 0.81 0.78 0.75 0.72 0.69 0.66 0.63 0.61 0.58 0.56 Rf 4.22%
PV (2.40) (2.30) (2.21) 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Total PV of FDA approval costs (today) (6.91)
Question #7
Decision tree simulation
At the end of 2008

FDA approval Low Baseline High
PV of FCFs (not include commercialization and FDA costs) 30.65 154.96 279.16
PV of commercialization costs (41.34) (41.34) (41.34)
NPV of the Product (10.68) 113.62 237.82
Disapproval
PV of FCFs (not include commercialization and FDA costs) 0
Question #8
Value the option by using the decision tree

At the end of 2008

FDA approval Low Baseline High
PV of FCFs (not include commercialization and FDA costs) 30.65 154.96 279.16
PV of commercialization costs (41.34) (41.34) (41.34)
NPV of the Product (10.68) 113.62 237.82
Disapproval
PV of FCFs (not include commercialization and FDA costs) 0
Question #9
Value the option to commercialize AquAdvantage Fish (Black-Scholes model)
Question #10
Fair firm value
Real option vs Black Scholes Model
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Fall

Corporate Finance Assignment 1

Scenario 1 - Low 2005 2006 2007 2008

Scenario 2 - Baseline 2006 2007 2008

Scenario 3 - High 2006 2007 2008

At the end of 2008

Value the option by using the decision tree

At the end of 2008

Value the option to commercialize AquAdvantage Fish (Black-Scholes model)

Fair firm value

Real option vs Black Scholes Model

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