Question

Using the free cash flow valuation model to price an IPO  Personal Finance Problem   Assume that it is the end of year 2015 and you have an opportunity to buy the stock of​ CoolTech, Inc., an IPO being offered for

​$4.33

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 developed from a variety of data sources. The key values you have compiled are summarized in the following​ table,

Free cash flow
Year​ (t)	FCF			Other data
2016	​$750,000			Growth rate of​ FCF, beyond 2019 to infinityequals=5 %
2017	​$900,000			Weighted average cost of capitalequals=13 %
2018	​$990,000			Market value of all debtequals=$2,300,000
2019	​$1,090,000			Market value of preferred stockequals=$920,000
				Number of shares of common stock to be issuedequals=1,100,000

.

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

a. The value of​ CoolTech's entire company is

​$ 11,497,477

The value per share of​ CoolTech's common stock is

​$ 7.52

b.  On the basis of 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 2019 will be

6​%

rather than

5​%.

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

b​?

c. If the growth rate in FCF beyond 2019 will be

6%

​, the value of​ CoolTech's entire company will be

​$ ? nothing.

​(Round to the nearest​ dollar.)

Answer 1

a)		2015	2016	2017	2018	2019
	FCF		$         7,50,000	$     9,00,000	$       9,90,000	$       10,90,000
	PVIF at 13%		0.88496	0.78315	0.69305	0.61332
	PV at 13%		$         6,63,717	$     7,04,832	$       6,86,120	$         6,68,517
	Sum of PV of FCF t2016 to t2019	$        27,23,186
	Continuing value of FCF = 1090000*1.05/(0.13-0.05) =					$   1,43,06,250
	PV of continuing value of FCF = 14306250*0.61332 =	$        87,74,309
	Value of the entire company	$    1,14,97,495
	Value of debt	$        23,00,000
	Value of preferred stock	$          9,20,000
	Value of equity	$        82,77,495
	# shares	1100000
	Value per share	$                  7.52
b)	As the offer price of $4.33 is less than the intrinsic
	value of $7.52, the stock can be bought at the offerred
	price.
c)	FCF		$         7,50,000	$     9,00,000	$       9,90,000	$       10,90,000
	PVIF at 13%		0.88496	0.78315	0.69305	0.61332
	PV at 13%		$         6,63,717	$     7,04,832	$       6,86,120	$         6,68,517
	Sum of PV of FCF t2016 to t2019	$        27,23,186
	Continuing value of FCF = 1090000*1.06/(0.13-0.06) =					$   1,65,05,714
	PV of continuing value of FCF = 16505714*0.61332 =	$    1,01,23,285
	Value of the entire company	$    1,28,46,470
	Value of debt	$        23,00,000
	Value of preferred stock	$          9,20,000
	Value of equity	$        96,26,470
	# shares	1100000
	Value per share	$                  8.75
	The decision is the same as the intrinsic value is more than the offer price.