Contract analysis

I. Executive Summary Whitmore Valuation Group LLC ("Whitmore" or "WVG") has been retained under a Kovel arrangement at the direction of Calderwood & Harkness LLP ("C&H"), counsel to Penterra Pharmaceuticals Corp. ("PPC"), to provide an independent economic analysis of the appropriate weighted average cost of capital ("WACC") for use in the income-method (Discounted cash flow, or "DCF") valuation of the platform contr

II. Scope and Methodology A. Engagement Scope Whitmore Valuation Group LLC was retained under a Kovel arrangement at the direction of Calderwood & Harkness LLP, counsel to PPC, pursuant to the Kovel Letter dated June 20, 2022 (C&H Matter Number 1018-00009-KV). Under this arrangement, Whitmore provides independent economic analysis and expert advisory services in defense of PPC before the IRS in connection with the Se

1. Risk-free rate — based on the yield on 20-year U.S. Treasury bonds as of the valuation date;

2. Equity risk premium ("ERP") — the expected excess return on equity markets over the risk-free rate;

3. Industry beta — the systematic risk measure for specialty pharmaceutical companies, derived from a set of publicly traded comparable companies;

4. Size premium — an incremental return adjustment reflecting the empirical observation that smaller companies (and carved-out income streams) command higher risk premiums;

5. Company-specific / asset-specific risk premium — an adjustment for risks unique to the PCT intangible property, including clinical-stage IP risk, geographic and regulatory risk in the Non-Americas Territory, and PBI's nascent operational status;

6. Cost of debt — PPC's after-tax borrowing cost as of the valuation date; and

7. Capital structure weights — the market-value proportions of equity and debt. The valuation date for all inputs is July 1, 2012, which is the effective date of the CSA and the date on which the PCT payment was made. All inputs are calibrated to market conditions as of the valuation date, consistent with the requirement that the arm's-length analysis be conducted based on the information and circumstances that were

III. Background: PPC and PBI Structure A. PPC Overview Penterra Pharmaceuticals Corp. ("PPC") is a Delaware corporation, publicly traded on the Nasdaq Global Select Market under the ticker symbol PPCA, and headquartered at 2200 Independence Boulevard, Princeton Junction, New Jersey 08550. PPC is a specialty pharmaceutical and biotechnology company focused on the development, manufacture, and commercialization of inno

1. CSA cost-sharing adjustments: The IRS contends that PBI's cost-sharing percentages for 2017–2020 should be increased to reflect the allegedly higher value of the pre-existing IP contributed by PPC, resulting in proposed adjustments of $235.01 million across the four examination years.

2. Royalty adjustments: The IRS further contends that certain intercompany royalty rates paid by PBI to PPC are understated in light of the higher PCT valuation, resulting in proposed adjustments of $188.04 million across the four examination years. After correlative offsets, the IRS's total proposed adjustments for the 2017–2020 examination years are approximately $380.4 million. These adjustments flow directly from

IV. WACC Component Analysis A. Risk-Free Rate

1. Selection of Benchmark The risk-free rate is the foundational component of the CAPM-based cost of equity and represents the theoretical rate of return on an investment with zero default risk and zero reinvestment risk. In practice, U.S. Treasury securities are used as the proxy for the risk-free rate because they carry the full faith and credit of the United States government and are the most liquid, default-risk-

2. IRS's Risk-Free Rate Based on our review of Dr. Washburne's analysis, it appears that the IRS selected a shorter-maturity Treasury instrument — specifically, the 10-year U.S. Treasury note yield — as its risk-free rate proxy. The 10-year Treasury yield as of July 1, 2012 was approximately 1.65%, significantly below the 20-year yield of 2.71%. This selection introduces a maturity mismatch between the risk-free rate

1. Historical ERP The equity risk premium represents the incremental return that investors demand for holding a diversified portfolio of equity securities rather than risk-free government bonds. The ERP is one of the most significant and debated inputs in the CAPM, and its estimation has been the subject of extensive academic and practitioner research. The long-term historical arithmetic mean equity risk premium, mea

2. Forward-Looking / Supply-Side ERP As an alternative to the purely historical approach, some practitioners and academics have advocated the use of a forward-looking or "supply-side" ERP, which is based on the fundamental factors that drive equity returns (earnings growth, dividend yields, and changes in price-to-earnings ratios) rather than historical realized excess returns. The supply-side ERP tends to be somewha

3. IRS's ERP Selection Based on our reconstruction of Dr. Washburne's analysis, it appears that the IRS selected an ERP of approximately 5.50%, which is at or below the lower bound of the range of well-supported ERP estimates as of the valuation date. While 5.50% is not outside the range of published estimates, it is below the median and below the level supported by the prevailing market conditions. The selection of

1. Comparable Company Selection Criteria The beta coefficient measures the systematic risk of a security relative to the overall equity market. In the CAPM framework, beta captures the portion of a company's total risk that cannot be diversified away and that investors therefore require compensation for bearing. For purposes of this analysis, we derived a pharmaceutical-industry beta from a set of publicly traded com

2. Beta Comparable Set Based on these criteria, we identified a set of twelve (12) comparable specialty pharmaceutical and biotechnology companies with sufficient trading history and data availability as of the valuation date. The comparable companies, their key financial characteristics, and their beta estimates are presented in detail in Appendix A to this memorandum. A summary is provided below: Notes: Raw betas b

3. Selected Beta To derive the appropriate re-levered beta for PPC, we re-levered the median unlevered beta using PPC's actual capital structure as of the valuation date. PPC's debt-to-equity ratio as of July 1, 2012 was approximately 0.19 (based on total debt of approximately $2.1 billion and equity market capitalization of approximately $11.1 billion). Using the Hamada equation with a 35% tax rate: βL = βu × [1 + (

4. Pharmaceutical-Industry-Specific Risk Factors Captured by Beta The beta coefficient for specialty pharmaceutical companies captures several industry-specific sources of systematic risk that are directly relevant to the PCT intangible property: Clinical development risk. Specialty pharmaceutical companies bear significant exposure to the outcomes of clinical trials, particularly Phase III pivotal trials in oncology

1. Rationale for Size Premium Empirical research has consistently demonstrated that smaller companies earn higher returns than predicted by the CAPM alone, after controlling for beta. This phenomenon, known as the size effect, is captured by adding a size premium to the CAPM-derived cost of equity. The size premium reflects the fact that smaller companies and smaller income streams are subject to risks — including lo

2. Size Premium Quantification Based on data from the Westmark Consulting Group Risk Premium Report (2012 edition) and the SBBI Valuation Edition, the size premium applicable to companies in the mid-cap range (defined by market capitalization of approximately $2 billion to $10 billion, which approximates the scale of the Non-Americas carve-out) was in the range of approximately 0.80% to 1.40% as of the valuation date

1. Justification. The CAPM, even when augmented by a size premium, may not fully capture all of the risks associated with a specific investment or income stream. In such cases, valuation practice and the regulatory framework under Treas. Reg. § 1.482-7(g)(4)(vi) support the addition of a company-specific or asset-specific risk premium (sometimes referred to as an "alpha" or "unsystematic risk premium") to reflect ris

2. Quantification. Based on the foregoing factors, we have determined that an asset-specific risk premium in the range of 1.0% to 3.0% is warranted for the PCT cash flows. For purposes of this analysis, we have adopted an asset-specific risk premium of 1.75%, which falls at the mid-point of the supportable range and reflects a balanced assessment of the following specific risk factors: (a) Pipeline attrition risk for

3. IRS's Failure to Account for Asset-Specific Risk The IRS's 7.2% WACC appears to include no asset-specific risk premium, or at most an inadequate one. This omission is a fundamental methodological error for several reasons: First, Treas. Reg. § 1.482-7(g)(4)(vi) expressly requires that the discount rate used in the income method for PCT valuations "reflect the riskiness of the relevant activities and the projected

1. PPC's Borrowing Cost The after-tax cost of debt is the second component of the WACC (in addition to the cost of equity). PPC's pre-tax cost of debt as of the valuation date is determined by reference to PPC's outstanding debt instruments and borrowing terms. As of July 1, 2012, PPC had access to a senior revolving credit facility administered by Hargrove National Bank, N.A. The facility provided total commitments

2. IRS's Cost of Debt Based on our review of Dr. Washburne's analysis, the IRS appears to have used a broadly similar pre-tax cost of debt, although the precise rate used by the IRS is not entirely clear from the available documentation. To the extent the IRS used a lower pre-tax cost of debt (for example, by relying primarily on the revolving credit facility rate rather than a blended rate incorporating the higher-c

1. Market-Value Capital Structure The WACC weights the cost of equity and the after-tax cost of debt by the proportions of equity and debt in the company's capital structure, measured at market value. Using market values rather than book values is the accepted approach in valuation practice because market values reflect the current opportunity cost of capital. As of July 1, 2012, PPC's capital structure was as follow

2. Target vs. Actual Capital Structure We considered whether it would be more appropriate to use a target capital structure (based on the median capital structure of the comparable companies) or PPC's actual capital structure as of the valuation date. The median debt-to-total-capital ratio for the twelve comparable companies was approximately 14.8%, and the mean was approximately 16.2%. PPC's actual debt-to-total-cap

V. WACC Build-Up Summary A. PPC / Whitmore WACC Derivation The following table presents the complete WACC build-up as derived by Whitmore Valuation Group: The unrounded WACC is approximately 9.82%, which we round to 9.8% for purposes of the DCF analysis. This rounding has a negligible impact on the resulting PCT valuation. B. IRS WACC Derivation (Reconstructed) Based on our review of Dr. Washburne's analysis and the

1. Risk-free rate maturity mismatch (~0.9 pp): The IRS's use of the 10-year Treasury yield (1.65%) rather than the 20-year yield (2.71%), which flows through both the CAPM directly and indirectly.

2. Equity risk premium (~0.6 pp): The IRS's selection of a below-median 5.50% ERP versus our 6.10%.

3. Beta understatement (~0.4 pp): The IRS's use of a 0.95 beta versus the 1.20 beta supported by the pharmaceutical comparable set.

4. Asset-specific risk premium (~0.4 pp): The IRS's nominal 0.50% asset-specific premium versus our 1.75%, reflecting the IRS's failure to adequately account for the specific risks of the Non-Americas IP stream.

5. Size premium omission (~0.3 pp): The IRS's apparent omission of any size premium adjustment. While no single component fully explains the 2.6 percentage point gap, the cumulative effect of the IRS's systematic downward bias across virtually every component of the WACC produces a discount rate that is materially understated and inconsistent with the risk characteristics of the pharmaceutical IP being valued.

VI. Sensitivity Analysis — Impact of discount Rate on PCT Valuation A. PCT Value at Various discount Rates The income-method DCF valuation is highly sensitive to the discount rate, particularly when the cash flow projection period is long (as is the case with pharmaceutical intangible property, where the projection period extends approximately 17–22 years). Small changes in the discount rate produce large changes in

VII. Critique of the IRS's 7.2% discount Rate A. Failure to Account for Pharmaceutical-Industry Risk The IRS's 7.2% WACC is below the cost of capital typically observed for specialty pharmaceutical and biotechnology companies. Published cost-of-capital data from multiple authoritative sources indicate that WACCs for specialty pharmaceutical companies as of mid-2012 generally ranged from approximately 9.0% to 12.0%, w