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 ​$16.27 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,

Year (T) FCF Other data

2020 $660,000 Growth rate of FCF, beyond 2023 to infinity=5%

2021 $810,000 Weighted average cost of capital=9%

2022 $920,000 Market value of all debt=4,260,000

2022 $1,000,000 Market value of preferred stock= $1,700,000

Number of shares of common stock to be issued = 1,100,000

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 6​% rather than 5​%.

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

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

W © V D C Ax 9 ENG 05:29 31-03-2020 ... o X PQ139 X ✓ fx PK. PL PM PP PQ PR PS PT PU A 121 YEAR PN 1 660000 PO 2 810000 3 4 122 FREE CASH FLOW 920000 1000000 123 TERMINAL VALUE 26250000.00 [=(1000000 *(1+0.05)/(0.09-0.05))] FCF3(1+g)/(WACC-g) 124 125 PRESENT VALUE OF ALL FCF OF 4 YEARS 126 1 127 YEAR FREE CASH FLOW PV FACTOR @9% PV OF ALL FCF 128 660000 0.917431 605504.59 810000 0.841680 681760.79 920000 0.772183 710408.80 1000000 0.708425 708425.21 2706099.39 129 130 131 FIRM'S HORIZON VALUE = 26250000.00 [=(1000000 *(1+0.05)/(0.09-0.05))] 132 133 134 FIRM'S TOTAL VALUE TODAY = PRESENT VALUE OF ALL FCF + PV OF HORIZON VALUE FIRM'S TOTAL VALUE TODAY = 2706099.39 + (26250000 x PVIF@9%, 4 YEARS) FIRM'S TOTAL VALUE TODAY = 2706099.39 + (26250000 x 0.708425) = 21302261.18 21302261 135 136 137 138 139 140 141 142 143 FIRM'S TOTAL VALUE 21302261.18 LESS MARKET VALUE OF DEBT 4260000 LESS AND PREFERRED STOCK 1700000 MARKET VALUE OF EQUITY 15342261.18 NO OF SHARES 1100000 PRICE PER SHARE 13.95 b NO, AS IT IS OFFERED AT 16.27, WHICH IS HIGHER THAN PRICE WE FOUND WHICH IS 13.95 ... FCF ARM, MSI,confidenceINDEX LOAN CURRENCY CROSS OVER GM HPRAM TAX | HEDGING MONEY MARKET GROWTH SUST PREF AND DIV POLICY ... • : D

W © V D C Ax 2 ENG, 05:30 E 31-03-2020 ... o X PQ167 X fc PK. PL PM PN PO PP PQ P R PS PT PU A 144 INCREASE IN GROWTH RATE WILL LEAD TO INCREASE IN VALUE OF FIRM AND THUS, INCREASE IN VALUE OF PRICE PER SHARE YEAR FREE CASH FLOW TERMINAL VALUE 660000 810000 145 146 147 148 149 150 151 152 153 154 920000 1000000 35333333.33 [=(1000000*(1+0.06)/(0.09-0.06))] FCF3(1+g)/(WACC-g) PRESENT VALUE OF ALL FCF OF 4 YEARS YEAR 3 155 FREE CASH FLOW PV FACTOR @9% PV OF ALL FCF 660000 810000 0.917431 0.841680 605504.59681760.79 920000 0.772183 710408.80 1000000 0.708425 708425.21 2706099.39 156 157 158 FIRM'S HORIZON VALUE = 35333333.33 [=(1000000*(1+0.06)/(0.09-0.06))] 159 160 161 FIRM'S TOTAL VALUE TODAY = PRESENT VALUE OF ALL FCF + PV OF HORIZON VALUE FIRM'S TOTAL VALUE TODAY = 2706099.39 + (35333333.33 x PVIF@9%, 4 YEARS) FIRM'S TOTAL VALUE TODAY = 2706099.39 + (35333333.33 x 0.708425) = 27737123.52 27737124 CROUNDED) 162 163 164 165 LESS FIRM'S TOTAL VALUE MARKET VALUE OF DEBT AND PREFERRED STOCK MARKET VALUE OF EQUITY 27737123.52 4260000 1700000 21777123.52 LESS 166 167 1 ... FCF ARM, MSI,confidenceINDEX LOAN CURRENCY CROSS OVER | GM HPR AM TAX HEDGING MONEY MARKET GROWTH SUST | PREF AND DIV POLICY ... + :

- W vocaux 23 ENG 05:30 = 31-03-2020 ... o X PQ174 - : X fx - PK. PL PM I PN PO PP PQ PR PS PT PU FCF3(1+g)/(WACC-g) 3 4 151 152 153 154 155 156 PRESENT VALUE OF ALL FCF OF 4 YEARS YEAR FREE CASH FLOW PV FACTOR @9% PV OF ALL FCF 660000 0.917431 605504.59 810000 0.841680 681760.79 920000 0.772183 710408.80 1000000 0.708425 7 08425.21 2706099.39 157 158 FIRM'S HORIZON VALUE = 35333333.33 (=(1000000*(1+0.06)/(0.09-0.06))] 159 160 161 FIRM'S TOTAL VALUE TODAY = PRESENT VALUE OF ALL FCF + PV OF HORIZON VALUE FIRM'S TOTAL VALUE TODAY = 2706099.39 + (35333333.33 x PVIF@9%, 4 YEARS) FIRM'S TOTAL VALUE TODAY = 2706099.39 + (35333333.33 x 0.708425) = 162 27737123.52 27737124 (ROUNDED) 163 164 165 LESS LESS 166 167 168 FIRM'S TOTAL VALUE MARKET VALUE OF DEBT AND PREFERRED STOCK MARKET VALUE OF EQUITY NO OF SHARES PRICE PER SHARE 27737123.52 4260000 1700000 21777123.52 1100000 169 19.80 170 171 172 173 174 YES, YOU SHOULD BUY THE STOCK YES, AS IT IS OFFERED AT 16.27, WHICH IS LOWER THAN PRICE WE FOUND WHICH IS 19.80 ... FCF ARM, MSI,confidenceINDEX LOAN CURRENCY CROSS OVER GM HPR AM TAX HEDGING MONEY MARKET GROWTH SUST PREF AND DIV POLICY ... + :