Castaway Company, a biotechnology startup, has developed a new seed for corn, which produces twice as much corn syrup as the seeds that are currently being used. Now, they want to sell the company and are interested in finding out how much it is worth.
This case is candidate-led, so allow the interviewee to answer the questions, only give hints when necessary. This case also requires significant quantitative analysis, with very less focus on qualitative evaluations and conclusions.
Short Solution (Expand) (Collapse)
Background 1 - to be provided before asking questions
- The price elasticity of demand for corn syrup is 1.
- The production process can be broken down into four main areas; farming (40% of costs), trucking (10% of costs), refining (30% of costs) and distribution (20% of costs)
- Farmland that is not used to grow corn can grow potatoes which is one fifth as profitable
- Trucking costs are 5% fixed and 95% variable
- Refining costs are all variable and it will cost 25% more per cob to refine the new corn, compared to the old cobs
Background 2 - to be provided if asked for by the interviewee
The market for corn syrup has grown at GDP over the last few years. Forecasts claim a growth of 2% annually
• Corn syrup is a mature commodity. The worldwide wholesale market is $2 billion a year.
• A 100% market penetration can be assumed, as no competing products exist
• Assuming the new corn seed can be protected by a patent, there should be no competition for several years
How much can Castaway Company save in costs and how much can they increase profits from farming?
- The new product reduces the land needed for farming corncobs by half. So it can be assumed that farmers will use half of their currently used land to grow potatoes. If an acre of land previously produced "X" profits of corn syrup, half an acre can now produce profits of "X" and half can produce "0.1X" profits from farming potatoes. Profits therefore go from X to 1.1X - increasing by 10%.
How high are the cost savings from refining, trucking, and distribution?
- Trucking - Variable costs of trucking (95% of total) decrease by 50% leading to cost savings of 90% x 50% = 47.5%
- Refining - Refining costs drop by half, as only half as many corncobs need to be refined, but there is a 25% increase in costs per cob. Hence, below the line there will be overall savings of 37.5%
Distribution - There are no savings within distribution
How high are the total cost savings in regard to the value chain?
What is the value of this product?
- The innovation will save 20% (cost savings/cost portion) a year in total corn syrup costs, which comes out at $400 million a year (20% x $2B)
- Value = Annual Cash/(discount rate - growth)
- Therefore, Value = $400M/(10%-2%) = $5B
- The product innovation will allow producers to grow corn syrup more efficiently, however it will not cause an increase in revenue as consumer demand will not increase. It will, however, reduce costs, causing profitability to increase
- According to NPV calculation, the value of the company is currently $5B
- There are some associated risks and potential benefits (e.g. adoption rates, competitor responses)