Question
In: Finance
Personal Finance Problem Assume that you have an opportunity to buy the stock of CoolTech, Inc.,...
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 toinfinity=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?
Solutions
Expert Solution
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.
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