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 ​$5.15 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 6​% rather than 5% hat effect would this finding have on your responses in parts a and b​?

year fcf

2020   720,000
2021   810,000
2022   950,000
2023   1,040,000
  

Other Data:

Growth rate of FCF, beyond 2023 to infinity = 5%

Weighted avg cost of capital = 12%

Market Value of all debt = $2,510,000

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

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

Answer 1

Value of firm is equal to the present value of all future cash flows

= 720,000/(1.12) + 810,000/(1.12)² + 950,000/(1.12)³ + 1,040,000/(1.12)⁴ + 1,040,000(1.05)/(1.12)⁴ (12%-5%)

= $12,539,796.24

Value of Equity = Value of firm – Value of Debt and preferred Stock

= 12,539,796.24 – 2,510,000-1,000,000

= $9,029,796.24

Value per share = 9,029,796.24/1,100,000

= $8.21

b.Yes, since price is lower than value

c.Value of firm = 14,302.299.71

Value per share = $9.81 per share

Still YES