Question

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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 $4.37 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 stocks offering price, should yo 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? a. The value of CoolTech's entire company is $1 (Round to the nearest dollar.) Data Table The value per share of CoolTech's common stock is $ . (Round to the nearest cent.) b. On the basis of your finding in part a and the stock's offering price, should you buy the stock? (Select the best answer below.) (Click on the icon here in order to copy the contents of the data table below into a spreadsheet.) O No Yes c. If the growth rate in FCF beyond 2023 will be 4%, the value of CoolTech's entire company will be $ (Round to the nearest dollar.) Free cash flow Year (t) FCF 2020 $690,000 2021 $790,000 2022 $900,000 2023 $1,040,000 The value per share of CoolTech's common stock is $ . (Round to the nearest cent.) Other data Growth rate of FCF, beyond 2023 to infinity = 3% Weighted average cost of capital = 13% Market value of all debt = $1,810,000 Market value of preferred stock = $720,000 Number of shares of common stock to be issued = 1,100,000 On the basis of your finding in partc and the stock's offering price, should you buy the stock? (Select the best answer below.) O A. No OB. Yes Print Done

Answer 1

a) Assuming we are valuing the price as of begining of 2020 and the FCF given are for the end of year 2020 690,000.00 2021 790,000.00 2022 900,000.00 2023 1,040,000.00 FCF So we will use the discounted cash flow method to value the company WACC 13% Value of the entity = 690000/(1.13) + 790000/(1.13)^2 + 900000/(1.13)^3 + 1040000/(1.13)^4 + 1040000*(1.03)/((0.13-0.03)*(1.13)-4) 9,060,772.18 Value of the common stock would be equal to total value minus debt and minus preferred stock 9060772.18-1810000-720000 6,530,772.18 Value per share = Total value of common stock/Number of shares being issued 6530772.18/1100000 5.94 b) Since the IPO is being offered at a price lower than its value we should buy the stock Yes

If the growth rate changes to 4%, then the terminal value will change So the value of the entity would be 690000/(1.13) + 790000/(1.13)^2 + 900000/(1.13)^3 + 1040000/(1.13)^4 + 1040000*(1.04)/((0.13-0.04)*(1.13)^4) 9,861,630.15 Value of common stock = 9861630.15 - 1810000 - 720000 7,331,630.15 Value per share = 7331630.15/1100000 6.67 Since the value of the stock is higher than the IPO price, you should buy the stock Yes