Question

P7–17 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 $12.50 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) FCFt Other data

2016 $ 700,000 Growth rate of FCF, beyond 2019 to infinity 5 2%

2017 800,000 Weighted average cost of capital 5 8%

2018 950,000 Market value of all debt 5 $2,700,000

2019 1,100,000 Market value of preferred stock 5 $1,000,000

Number of shares of common stock outstanding 5 1,100,000

a. Use the free cash flow valuation model to estimate CoolTech’s common stock

value per share.

b. Judging 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

3% rather than 2%. What effect would this finding have on your responses in

parts a and b?

Solve using Excel

Answer 1