Question

Charger Books generates $60 million in FCF. It wants to go public (conduct an IPO, initial public offering of common stock) and have its new stock trade on the NASDAQ. You’ve done the research to know that companies like this trade at a seven (7) times multiple of FCF. Charger Books has $40 million of debt outstanding and $10 million of preferred stock. Calculate the intrinsic value per COMMON share if the company plans to have 50 million common shares outstanding after the deal. Show your answer to TWO decimals.

Answer 1

The question provides us information which is as follows -

Current FCF or Free Cash Flow = $60 million

Value of debt = $40 million , Value of preference shares = $10 million

FCF refers to free cash flows of the firm that is cash available to all capital providers - debt, equity and preference after taking care of capital expenditures and working capital needs of the firm. It is one of the most important figure calculated when finding out the value of firm.Valuing firm with P/E ratio, EBITDA, operating cash flows, etc. also has disadvantages. They ignore factors like additional capital expenditure paid for by the firm. So they fail to provide a good assessment of the value of the firm. FCFF is calculated as -

EBIT (1 - t) - (Capex. - Depreciation) - Change in working capital

Here,

EBIT = Earnings Before Interest and Tax

Capex = Capital expenditure

t = Tax rate

FCF helps us estimate the value of firm and is widely used for valuation purposes.

Our research tells us that firms of this kind trade at 7 times multiple of FCFF, which means value of company is -

Value = FCF * 7

= $60 million * 7

= $420 million

Now, we will reduce given value of debt and preference share from value of firm calculated above -

Value of firm - Value of debt - Value of preference share capital

= $420 million - $40 million - $10 million

= $370 million

This figure will help us calculate the intrinsic value of shares. The value of firm is nothing but the claims of capital providers against the firm. The combined figure of values of funds provides us with value of the firm.

So, Value of firm = Value of debt + Value of equity + Value of preference shares

Value of equity = $370 million

Intrinsic value will be = Value of equity / No. of outstanding shares

As number of common shares to be issued by the firm after going public is 50 million, intrinsic value is as follows -

Intrinsic value per share = $370 million / 50 million

= $7.40 per share

Thus the intrinsic value for this company's common share will be $7.40 per share.