Question

Using the free cash flow valuation model to price an IPO

Assume that you have an opportunity to buy the stock of​ CoolTech, Inc., an IPO being offered for $12.30 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,

2016   800,000
2017   800,000
2018   940,000
2019   1,090,000

Other information:

Number of shares of common stock to be issued equals=1,100,000
Market value of preferred stock equals=$1,290,000

Market value of all debt equals=$3,210,000

Weighted average cost of capital equals=9%

Growth rate of​ FCF, beyond 2023 to infinity equals=3%

Question:

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

c. On further​ analysis, you find that the growth rate in FCF beyond 2023 will be 4​% rather than 3​%.

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

Answer 1