Question

Personal Finance Problem   Assume that you have an opportunity to buy the stock of​ CoolTech, Inc., an IPO being offered for

​$12.37 per share. Although you are very much interested in owning the​ company, you are concerned about whether it is fairly priced. To determine the value of the​ shares, you have decided to apply the free cash flow valuation model to the​ firm's financial data that​ you've accumulated from a variety of data sources. The key values you have compiled are summarized in the following​ table,

2020   720,000
2021   860,000
2022   980,000
2023   1,100,000
  

Growth rate of​ FCF, beyond 2023 to infinity=6%
2021	​$860,000			Weighted average cost of capital=11%
2022	​$980,000			Market value of all debt=$3,630,000
2023	​$1,100,000			Market value of preferred stock=$1,450,000
				Number of shares of common stock to be issued=1,100,000

.

a. Use the free cash flow valuation model to estimate​ CoolTech's common stock value per share.

b.  Judging by your finding in part a and the​ stock's offering​ price, should you buy the​ stock?

c. On further​ analysis, you find that the growth rate in FCF beyond

2023

will be

7​%

rather than

6​%.

What effect would this finding have on your responses in parts a and

b​?

Answer 1

The market price is $12.37 per share. To find whether it is fairly priced or not, we can compare the intrinsic value of the stock using FCF valuation with the market price of the share.

Given here is FCFF(Free cash flow to the firm). To find the intrinsic value per share, we have to find the overall value using FCFF valuation, deduct the market value of the preferred stock and debt and then divide it by the number of outstanding shares.