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 $8.47 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, IL 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? a. The value of Cool Tech's entire company is $. (Round to the nearest dollar.) Data Table (Click on the icon here in order to copy the contents of the data table below into a spreadsheet.) Free cash flow Year(t) FCF 2020 $700,000 2021 $830,000 2022 $940,000 2023 $1,050,000 Other data Growth rate of FCF, beyond 2023 to infinity = 5% Weighted average cost of capital = 13% Market value of all debt-$2,200,000 Market value of preferred stock = $880,000 Number of shares of common stock to be issued = 1,100,000

Answer 1

a). Intrinsic value per share (using FCF model) = 7.22 per share

Value of the entire company = 11,017,231

2020 2021 2022 2023 2024 1 2 3 4 5 700000 830000 940000 1050000 5% 1102500 13781250 619469.03 650011.75 651467.15 643984.66 8452298.72 Formula Year Time (n) Growth rate (g) FCF5 = FCF4*(1+g) Free cash flow (FCF) FCF5/(13%-g) Terminal value (TV) FCF/(1+13%)an PV of FCF TV/(1+13%)^4 PV of TV Sum of all PVs of FCFs & TV Firm value Less: Debt Less: Preferred stock Add: Cash Firm value - debt - pref, stock + cash Equity value Number of shares Equity value/number of shares Price per share 11017231 2200000 880000 0 7937231.3 1100000 7.22

b). The intrinsic value of the stock is $7.22 per share whereas its offer price is $8.47 per share so the stock is overvalued. It should not be purchased.

c). If terminal growth rate is 6% then intrinsic value per share becomes $8.40 per share. The stock is still overvalued so it should not be purchased.

Value of the entire company = 12,316,700

2020 2022 2024 2021 2 2023 4 1 3 5 6% 1113000 159000001 700000 830000 940000 1050000 619469.03 650011.75 651467.15 643984.66 9751767.77 Formula Year Time (n) Growth rate (g) FCF5 = FCF4*(1+g) Free cash flow (FCF) FCF5/(13%-g) Terminal value (TV) FCF/(1+13%)^n PV of FCF TV/(1+13%)^4 PV of TV Sum of all PVs of Firm value Less: Debt Less: Preferred stoc Add: Cash Firm value - debt - pref. stock + cash Equity value Number of shares Equity value/number of shares Price per share 12316700.36 2200000 880000 0 9236700.36 1100000 8.40