Which company is likely to have a higher terminal value as a percentage of EV, a biotech company or a consumer staples company, and why?

The rationale behind the choice pointing to the biotech company having a higher terminal value as a percentage of enterprise value (EV) primarily lies in the growth potential associated with the biotech sector. Biotech companies usually engage in the research and development of innovative therapies and technologies, which can lead to significant breakthroughs, especially when they successfully bring a new drug or product to market. This potential for high future cash flows increases their terminal value, which represents the value of a company at the end of a forecast period, often reflecting its expected long-term growth rate.

In contrast, consumer staples companies operate in established markets with predictable demand for their products. They are characterized by stable cash flows, but their growth rates are typically lower than biotech firms. This stability results in a lower terminal value as a percentage of EV because their market growth prospects are more limited, and they do not possess the same level of upside potential that can significantly influence future valuations.

Thus, the inherent possibilities for growth and innovation in a biotech company lead to a higher expected terminal value when compared to a consumer staples company, making it the correct choice in this context.