Question

Using the free cash flow valuation model to price an IPO Personal Finance Problem Assume that you have an opportunity to buy the stock of CoolTech, Inc., an IPO being offered for $5.54 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, 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? c. On further analysis, you find that the growth rate in FCF beyond 2023 will be 3% rather than 2%. What effect would this finding have on your responses in parts a and b?

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

в с р F G 2% Growth rate beyond 2023 WACC Market value of all Debt Market value of Preferred stock No. of Shares of common stock to be issued 13% $1,840,000 $740,000 1,100,000 Growth rate beyond 2023 WACC Market value of all Debt Market value of Preferred stock No. of Shares of common stock to be issued 3% 13% $1,840,000 $740,000 1,100,000 Year 2020 2021 2022 2023 FCF $750,000.00 $850,000.00 $990,000.00 $1,140,000.00 Year 2020 2021 2022 2023 FCF $750,000.00 $850,000.00 $990,000.00 $1,140,000.00 15 16 17 18 PV of Non-constant FCF Terminal value at end of 2023 PV of Terminal value Value of Firm today $2,714,694.51 $10,570,909.09 $6,483,336.51 $9,198,031.02 PV of Non-constant FCF Terminal value at end of 2023 PV of Terminal value Value of Firm today $2,714,694.51 $11,742,000.00 $7,201,588.50 $9,916,283.01 19 Value of common stock today $6,618,031.02 Value of common stock today $7,336,283.01 20 21 a. Value of Per share of common stock today $5.81 Value of Per share of common stock today $6.44 22 $5.54 Issue price of per share of common stock Issue price is less than fair value of each share, Thus, 23 b. 24 25 26 27 28 c. You should buy the stock 3% 29 If growthr rate Then, Fair value share of stock price increased to 30 $6.44 31 Decision will remain same, You should buy the stock

Cell reference -

B F co von AwN- Growth rate beyond 2023 WACC Market value of all Debt Market value of Preferred stock No. of Shares of common stock to be issued 0.02 0.13 1840000 740000 1100000 Growth rate beyond 2023 0.03 WACC 0.13 Market value of all Debt 1840000 Market value of Preferred stock 740000 No. of Shares of common stock to be issued 1100000 Year Year FCF FCF 750000 850000 990000 1140000 2020 2021 2022 2023 2020 2021 2022 2023 750000 850000 990000 1140000 11 13 PV of Non-constant FCF Terminal value at end of 2023 PV of Terminal value Value of Firm today =NPV(C3,C9:C12) =(C12*(1+C2))/(C3-C2) =C15/(1+C3)^4 =C14+C16 PV of Non-constant FCF Terminal value at end of 2023 PV of Terminal value Value of Firm today =NPV(F3,F9:F12) =(F12*(1+F2))/(F3-F2) =F15/(1+F3)^4 =F14+F16 Value of common stock today =C17-C4-C5 Value of common stock today =F17-F4-F5 20 21 a. Value of Per share of common stock today =C19/012 Value of Per share of common stock today =F19/F12 22 23 b. 5.54 Issue price of per share of common stock Issue price is less than fair value of each share, 24 25 26 Thus, You should buy the stock 27 28 c. 0.03 If growthr rate Then, Fair value share of stock price increased to =F21 Decision will remain same, You should buy the stock

Hope it will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.