Question

1. Etna Tech is a company set up by two friends, Larry and Mike. The company’s only product is a popular online game called Fisticuffs. Etna Tech will be holding an IPO of 5 million shares tomorrow. Market expectations are high for this IPO. The company is expected to pay $1 per share starting one year from now. The dividends are then expected to grow at a supernormal rate of 30% for three years, before dropping down to 15% for three more years, and then to 5% afterwards. What is the total value of this IPO if the required return for similar issues is 18%?  

Answer 1

Answer:

Number of shares of the IPO = 5 million

Let us calculate share value per share based on expected dividend payments using dividend discount model:

Expected dividend:

Year 1 = $1

Year 2 = $1 * (1 + 30%)

Year 3 = $1 * (1 + 30%) ²

Year 4 = $1 * (1 + 30%) ³

Year 5 = $1 * (1 + 30%) ³ * (1 + 15%)

Year 6 = $1 * (1 + 30%) ³ * (1 + 15%) ²

Year 7 = $1 * (1 + 30%) ³​​​​​​​ * (1 + 15%) ³

Year 8 = $1 * (1 + 30%) ³​​​​​​​ * (1 + 15%) ³ * (1 + 5%)

Dividends will be as follows:

As dividend is expected to grow at 5% 8th year onwards:

Value of share at the end of year 7 = Year 8 Dividend / (Required return - Constant growth rate)

= ($1 * (1 + 30%) ³​​​​​​​ * (1 + 15%) ³ * (1 + 5%)) / (18% - 5%)

= $26.98792

If we include the value of share at the end of year 7 in cash flow, cash flows, PV factor and current value per share and IPO value will be as follows:

Hence:

IPO value in millions = $78.22 million

IPO value in dollars = $78,223,370