There are three basic methods of technology valuation based on cost, market and income approaches. These methods are not complex investment models, and are based rather on the logical analysis of the existing information on a new technology. There are also several more sophisticated methods implying more complex mathematical calculation.

The cost approach is based on the assessment of the costs of developing a new technology.

For the developer, the value of the new technology is equal to the total amount of costs associated with its development, including indirect costs for infrastructure, utility, manpower, taxes etc.

The buyer estimates the future costs for replication of the similar technology in-house, hedging the organizational and country risks in the specific case.

This method can be potentially applied to the transfer of equipment and other tangible assets. But it is almost impossible to estimate costs for the creation of intellectual property which is purely intangible. It is obvious that the coast approach of valuation is highly subjective. For example, some of the supplier’s costs could be a result of his (her) inefficient management. So, from the buyer’s point of view these costs will be not justified. Another drawback of the coast approach is that it doesn’t reflect the future income of the new technology and its market position.

However, the cost approach can be a basis for the initial stages of negotiations. It can be helpful in understanding the other party’s position.  Moreover, this method can be useful in the establishing of a joint venture, to evaluate the investments made ​​by each party.

The market approach is based on the comparison of value of similar technologies that are already available on the market. This method is a reliable way to get the market price for which at the moment technology can be acquired.

However, in practice, the active market of new technologies doesn’t always exist. For example, in case of a breakthrough technology, it is difficult to find the comparable equivalents. Even if the market of similar technologies exists, to apply the market approach we need an open access to the information about the transactions on this market.

Besides, the market approach, as well as the cost approach doesn’t reflect the future income generated by a new technology.

The income approach is based on the expectation of future cash flows resulting from the technology implementation. This method determines the profit-creating potential of the new technology. The value of technology is considered as the difference between the cash inflows and outflows over a certain period of time.

The main drawback of the estimation of future revenues is the uncertainty of any long-term prediction. The key point of such estimation is the risk associated with each factor potentially affecting both market (future demand, regulation, exchange rate, etc.) and technology which can become obsolete.

That’s why we can find different facets of the income approach. Each of them is taking into account different aspects influencing future profits from the new technology. Among them the most widely used is the discounted cash flow method.

Discounted cash flow method (DCF) is based on the concept of the time value of money which says that a certain amount of money today has different buying power than the same amount of money in the future.

The DFC method evaluates the present value of future cash flows.
Present Value = Future value / (1+discount rate) i

Future value represents the sum of expected cash flows in a future period;

i is the year of the projection period;

Discount rate reflects different types of risks that affect the future income. For example, risks associated with inflation, taxation, changes in the cost of raw materials and energy, company and country development

The value of technology is calculated as a sum of future earnings for each year of the forecast period adjusted at the proper discount rate.

The main issue of the DCF method is the determination of the discount rate. There are various models of its calculation which are typically based on an advanced mathematical approach. The most widespread model used to calculate a discount rate is the capital asset pricing model (CAPM).

The use of mathematical calculation can be considered on the one hand as an advantage of the DCF method, which allows to accurately determine the technology value.

But on the other hand, this calculation relies heavily on the assumptions of risks and future cash flows. So, the objectivity of the technology value depends on the objectivity of the assumptions that were made. The omission or incorrect prediction of one of the parameters affecting the future value can drastically distort the final result.

Moreover, the complex mathematical calculations have high sensitivity to input parameters change. Even small errors in assumed values ​​can exponentially change the outcome of the valuation. Consequently, two valuations of the same technology, made by two different analysts can give completely different results.