Types of Risks in Triantis That Is Applicable to the CSL Company - Term Paper Example

Names Institution Name Date Synopsis and Introduction The aim of the report is to study CSL Limited, which is the largest listed Australian Pharmaceuticals & Biotechnology Company and has numerous branches across the world. The purpose is to utilize real options and financial options in understanding the risks and strategies, and analysis of the risks. Some of the tasks completed include identification of risks, utilization of CSL data in real options analysis, how risks affected an organization and reviewing some researches and developments that CSL has done or continues to develop. Identification of the Types of Risks in Triantis (2000) that is Applicable to the CSL Company Triantis (2000) identifies numerous risks, which include legal/regulatory, performance, financial, economic and technological categories. CSL faces competition from other biotechnology and pharmaceutical companies. The speed of products introduction into the market may affect future sales including lowering the prices of the products (Bulan, Mayer and Somerville 2009). It creates a challenge in accessing potential marketing since value-creating business development is important in advancing CSL financial and business performance. CSL understands the threats of the regulatory and legal framework because the company operates in numerous different jurisdictions (CSL 2016). CSL has to understand the emerging and current regulatory frameworks and continuous engage with the stakeholders in uploading the regulatory and legislative framework (Bulan, Mayer and Somerville 2009). It means CSL has to comply with the regulatory authorities, about the numerous jurisdictions and adherence with the regulatory frameworks are important. In the business risks context, CSL continues to acquire new business in mergers and acquisitions, but these processes expose the company to numerous risks including cultural and operational requirements (de Neufville et al. 2008). CSL has to align the organization opportunities, culture and vision with acquisition and merging strategies (CSL 2016). However, mismatch of these different processes affects the business in a negative way (Bulan, Mayer and Somerville 2009). Combining and balancing the business activities may create divisions within the employees and top management, and engaging the employees and internal resources is important (Tong, Reuer and Peng 2008). Hence, poor integration is a major issue in advancing the requirements of the business. CSL faces risks in the financial sector because it operates in different markets that use different currencies (de Neufville et al. 2008). The currency in pricing keeps changing based on the financial environment, which results in commodity price risk (Bulan, Mayer and Somerville 2009). CSL continues to seek for loans and financing options which expose the company to interest rate risks and current rate risk. It means CSL has to create a framework, which balances the financial dynamics with internal financial and operational requirements (CSL 2016). Technological advancement is an integral component in research and development requirements at CSL (Cao, Simin and Zhao 2008). The technological capacities include the software, hardware and the relationship between these components (de Neufville et al. 2008). The research and development have major risks because of the chances of success and the complications in the phases involved in the research and development (Kolb and Overdahl 2010). The manufacturing facilities may face production breakdown or even the quality of the raw materials including the ingredients to utilize the technology may affect the entire operational and financial requirements (Bulan, Mayer and Somerville 2009). Performance is a major issue at CSL because it relies on performance to achieve the mission and vision requirements (de Neufville et al. 2008). CSL requires partnerships and enters into numerous contractual agreements with contractors and subcontracts (Grullon, Lyandres and Zhdanov 2012). Some of the activities that contractors have to complete include the supply chain requirements, the supply of ingredients, quality assurance in engagement with the customers, and whether these contracts adheres to the regulatory and legislative framework in terms of governance and integrity requirements (Cao, Simin and Zhao 2008). Any misdirection by these contractors and subcontractors means CSL can have a negative public relations because of the principle of association. The Mechanism by which These Risks May Affect the Valuation of the Company The valuation of a business depends on the manner in which the business is managed including strategic requirements (de Neufville et al. 2008). The business approach requirements effective contractual and partnerships to accomplish the objectives of the business (Vanhaverbeke, Van de Vrande, and Chesbrough 2008). Misunderstandings with the partners especially the logistics companies means that the products will not be delivered to the customers reducing the number of sales and customers thinking of acquiring products from competing entities (Cao, Simin and Zhao 2008). These problems affect the overall business position since the share price will drop while the amount of sales diminishes (Bulan, Mayer and Somerville 2009). The research and development sector is important to the advancement of overall revenue generation and benefits to the company (Ruijter and Oosterlee 2012). The existence of the company relies on continued development and introduction of new products to the market (Grullon, Lyandres and Zhdanov 2012). The research and development also have to adhere to different jurisdictions requirements and applying for approvals are important (de Neufville et al. 2008). Ineffective research and development results in decreased sales affecting the overall development of the company (Hillier, Grinblatt and Titman 2011). The approval and adhering to the numerous legislations is important, and lack of adherence means the company is penalized including revocation of permits and licenses (Bulan, Mayer and Somerville 2009). These directly affects the valuation of the company because of lost opportunities and other institutional requirements. Application of the Data to the Case Analysis a. Why are real options seen as risk reduction strategies? The aim of numerous researches and projects is to generate a positive outcome, and it is imperative to determine whether the implementation of a project is beneficial to the company (McCarter, Mahoney and Northcraft 2011). The real options approach is aimed at determining whether it is viable to execute some projects (CSL 2016). For example, projects should not be implemented when the conditions are poor, or strategic implementation options increase the project value (Van Bekkum, Pennings and Smit 2009). Without the implementation of the strategies during the appropriate time affects the overall benefit of the development and through the use of risk reduction strategies, it is possible to proceed with the project effectively. Real options are important because it sometimes reflects the actual project conditions (Grenadier and Malenko 2011). For example, some of the variables and factors of real options include independence of the option holders from the underlying asset and future performance, few and independent options, arbitrage opportunities, complete markets for assets and behavior of future asset values (Kumbaroğlu, Madlener and Demirel 2008). It is difficult to incorporate these different variables in determining the viability of the project if approaches such as real options are not included (Liang, Wang and Li 2012). Hence, real options are the best alternative to address the complexities of the project and institute measures to support the project expectations. b. How can real and financial options be used to manage these risks? Proactive use of operational flexibility ensures an establishment employ strategies against pursuing unviable goals and objectives (Pavlov and Wachter 2009). It includes redefining the strategic requirements and ensuring the different entities defining the project are incorporated in the design and implementation needs (Brigham and Ehrhardt 2013). For example, the real options enable an organization to predict the use of financials and the estimated outcome of the investments (de Neufville et al. 2008). It also enables identification of areas, which have to be adjusted to accomplish the implementation requirements. Functional coordination across different areas ranging from manufacturing technology to product design are incorporated into a single framework (Van Bekkum, Pennings and Smit 2009). In a normal organization, it is important to align the different processes, and this can be achieved through the use of real and financial options (Campello, Graham and Harvey 2010). For example, in the pharmaceutical and biotechnology industry, numerous components of management and infrastructural requirements are crucial. For instance, the research and development are one of the numerous aspects of pharmaceutical industries while others are the infrastructure and technology (Fernandes, Cunha and Ferreira 2011). Aligning and Balancing the requirements through running financial simulations and determining viable projects enables management of the risks and threats. The real and financial options also enables turning the numerous processes with risks evident in the projects with solutions (Smit and Trigeorgis 2012). Introduction of a new product in the market follows numerous phases and requires continuous approval from legislative and governmental institutions (Qin and Nembhard 2010). The financial and real options provides mechanism of determining viability of the project depending on the phase and historical data from the project (de Neufville et al. 2008). For example, creating a new product requires phases from the research, clinical phase, trials, seeking for approval and the marketing requirements (Bulan, Mayer and Somerville 2009). Each phase needs financial requirements implying the options provides means to determine when to stop or proceed with the project. Complexity of the projects and requirement of balancing numerous projects requires a process that enables incorporation of numerous variables (Driouchi and Bennett 2011). It requires a framework that defines when to stop the project, make adjustments relevant to the project, and determine the future of the projects. Available data informs the success of numerous medical research are few since most of the projects are stopped before completion or a different approach (de Neufville et al. 2008). It raises complexity requirements since utilizing the normal approaches such as discounting may not clarify the numerous diversions (Bulan, Mayer and Somerville 2009). The use of financial and real options ensures the complexity of the project is financed based on the strategic objectives of the company. c. What are your recommendations to the financial managers Financial managers operate in a risk-rich environment because the drug manufacturing and associated processes is risky and requires voluminous funds (de Neufville et al. 2008). It is “risk-rich” environment because of the potentials benefits of successful drugs but also the threats of negative consequences of the drugs in terms of investment costs and the litigations associated with poorly researched drugs (Smit and Trigeorgis 2012). Managers have to appreciate any technique that improves the decision making processes, and using the financials options and real options is alternative approaches is making credible decisions (de Neufville et al. 2008). Relying on a single strategy may not be appropriate because of the constraints of the project and the solution is to use divergent approaches in arriving at a strategic conclusion. Financial managements have to appreciate the benefits of financial options and real options in addressing risks (Christopher and Holweg 2011). The design of the financial options can result in the same contingent payoff structure compared with the real option provided the derivate shares similar variables. The financial managers have to balance the strengths of the financial and real options (Bulan, Mayer and Somerville 2009). For instance, in setting a global network of production includes reconfiguring the supply chain, investing in new plants, switching costs, losing economies of scale and maintaining capacities of productions, which requires allocation of financial and real options (de Neufville et al. 2008). Balancing the requirements illustrates the importance of financial managers employing different tools in ensuring the establishment generates revenue. Pick an early stage research and development project of the company d. Why are real options seen as value enhancement strategies? The revenue enhancement effect is based on the opportunities of real options to leverage certain exogenous business conditions such as the appropriateness of expanding the business based on the environmental changes and to capitalize on the upside project potential (Oriani and Sobrero 2008). The real option enables inclusion of different variables as the project to proceed depending on the visible outcome of the project (Tang and Musa 2011). For example, the research and development department in a pharmaceutical company starts with researching about a product, and the aspect develops through the construction of appropriate infrastructure to support the outcome of the products (Grullon, Lyandres and Zhdanov 2012). The strategic requirements are creating a unique approach in which it joins the different phases and stages until the project is completed without wasting time (Bulan, Mayer and Somerville 2009). For instance, waiting until the project is completed so that the next phase is implemented, the time loss affects the entire processes of the project (Bensoussan, Diltz and Hoe 2010). A solution is to utilize the real options to identify and capitalize on early stage research requirements to continue to develop the strategic obligations (de Neufville et al. 2008). e. How can different types of real options valuation techniques be applied to capture value in the early stages of this investment? CSL324 is one of the breakthrough medicines, which is still in the research/pre-clinical stage. The research and development have to go through numerous phases including clinical development, registration, and launch. In the financial period, 2015, the money used to fund research and development was USD 614 million. No specific budget has been located for the development of CSL324 and estimates (the estimates are in a million) are used for the purpose of this assignment. Time based option The important data are: R = 7% PV at t = 0: $60 PV at t = 1: if the demand is high: $75 PV at t = 1: if the demand is low: $40 Estimate cash flow – high demand year: $10 Estimate cash flow: low demand year: $4 Initial cost of the CSL324 project: $50 In valuing an option, the information required are: U = the up factor D = the down factor Q = probability of an up move 1 – q = the probability of a down move In calculating the value of q, the following equation is applicable Where U = up factor R = 1 + Rf D = down factor It is important to recall up = u X S 75 + 10 = u X S where S = 60 U = 85/60 = 1.42 In calculating d; 40 + 4 = d X 60 D = 44/60 = 0.73 It is important to complete the assumption 0 < q < 1 Q = 0.34/0.7 = 0.49; which holds. The payoff is given by: Cu = max [75 – 50, 0] = 25 Cd = max [4 – 50, 0] = 0 C = 12.25 / 1.07 = $11.45 million If the project is continued = max [S – X, 0] = max [60 -50] = $10 million Since the value is lowered at $10 million compared with the alternative, which is $11.45 million, it is appropriate to invest in the project Option to abandon the project The cost of the project is estimated at $50 million, and it is expected the project will take five years. The following tables summarizes the data:   research/preclinical Clinical development Registrations/post launch   Year 1 Year 2 Year 3 Year 4 Year 5 50 71 100.82 143.1644 203.3 288.686   36.5 51.83 73.5986 104.51 148.409     26.645 37.84 53.7328 76.3       19.345 27.6232 39.22 Up is 1.42       14.121 20.165 Down is 0.73         10.31 If the project goes as expected, the revenues will be more than $288.686 million while the worst scenario after the five years, the remaining amount is $10.31 million f. How would valuations compare if the discounted cash flows techniques are used? A discounted cash flow is a strategy used in estimating the attractiveness of an investment (de Neufville et al. 2008). It utilizes future free cash flow discounts projects and then discounts the projects into arriving a present value estimate, which is utilized as mechanisms to evaluative investment potential (Bulan, Mayer and Somerville 2009). The real option value method is utilized as an alternative to the discounted cash flow approach since the real option incorporates the management flexibility (Shockley et al. 2003). However, these approaches present a different perspective when analyzing risks. Real option strategy applies the risk adjustment technique since the cash flow is uncertain while the discounted cash flow make adjustments based on the aggregate risk level of cash flow (Bulan, Mayer and Somerville 2009). 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