Using the free cash flow valuation model to price an IPO Assume that you have an
ID: 2713882 • Letter: U
Question
Using the free cash flow valuation model to price an IPO Assume that you have an
opportunity to buy the stock of CoolTech, Inc., an IPO being offered for $12.50 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 developed from a variety of data sources. The key values you have compiled
are summarized in the following table.
Free cash flow
Year (t) FCFt Other data
2016 $ 700,000 Growth rate of FCF, beyond 2019 to infinity 5 2%
2017 800,000 Weighted average cost of capital 5 8%
2018 950,000 Market value of all debt 5 $2,700,000
2019 1,100,000 Market value of preferred stock 5 $1,000,000
Number of shares of common stock outstanding 5 1,100,000
a. Use the free cash flow valuation model to estimate CoolTech’s common stock
value per share.
b. Judging on the basis of 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 2019 will be
3% rather than 2%. What effect would this finding have on your responses in
parts a and b?
Explanation / Answer
where
Terminal value = year 2020 cashflow/(WACC - growth rate)
Value of equity = firm value - market value of debt - market value of prefered equity
= 16641750.92 - 2700000 - 1000000 = 12941750.92
Price per share = value of equity / number of outstanding shares = 12941750.92/1100000 = 11.7652
2) Stock should not be bought as intrinsic value is less than IPO price
3)
Value of equity = firm value - market value of debt - market value of prefered equity
= 19552469.14 - 2700000 - 1000000 = 15852469.14
Price per share = value of equity / number of outstanding shares = 15852469.14/1100000 = 14.4113
Stock should be bought as intrinsic value is more than IPO price
WACC 8% Year Period Growth rate FCF Terminal value Total Value Discount factor Discounted value 2016 1 0% 700000 700000 1.08 648148.1481 2017 2 0% 800000 800000 1.1664 685871.0562 2018 3 0% 950000 950000 1.259712 754140.629 2019 4 0% 1100000 18700000 19800000 1.36048896 14553591.09 2020 5 2% 1122000 Value of firm = Sum of discounted value= 16641750.92Related Questions
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