P7–17 Using the free cash flow valuation model to price an IPO Assume that you have...

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Finance

P7–17 Using the free cash flow valuation model to price an IPOAssume that you have an
opportunity to buy the stock of CoolTech, Inc., an IPO beingoffered for $12.50 per
share. Although you are very much interested in owning thecompany, you are concerned
about whether it is fairly priced. To determine the value of theshares, you
have decided to apply the free cash flow valuation model to thefirm’s financial data
that you’ve developed from a variety of data sources. The keyvalues 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 52%
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’scommon stock
value per share.
b. Judging on the basis of your finding in part a and thestock’s offering price,
should you buy the stock?
c. On further analysis, you find that the growth rate in FCFbeyond 2019 will be
3% rather than 2%. What effect would this finding have on yourresponses in
parts a and b?

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4.4 Ratings (951 Votes)

a to find out the value of the common stock per share we will first calculate the value of the firm as a whole and then subtract the market value of all debts and preferred stock Given r 8 g 2 Value of the firm is the present value of all the future cash flows Value CF1 1 r CF2 1 r2 CF3 1 r3 CF4 1 r4 TV 1 r4 where terminal See Answer

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P7–17 Using the free cash flow valuation model to price an IPOAssume that you have anopportunity to buy the stock of CoolTech, Inc., an IPO beingoffered for $12.50 pershare. Although you are very much interested in owning thecompany, you are concernedabout whether it is fairly priced. To determine the value of theshares, youhave decided to apply the free cash flow valuation model to thefirm’s financial datathat you’ve developed from a variety of data sources. The keyvalues you have compiledare summarized in the following table.Free cash flowYear (t) FCFt Other data2016 $ 700,000 Growth rate of FCF, beyond 2019 to infinity 52%2017 800,000 Weighted average cost of capital 5 8%2018 950,000 Market value of all debt 5 $2,700,0002019 1,100,000 Market value of preferred stock 5 $1,000,000Number of shares of common stock outstanding 5 1,100,000a. Use the free cash flow valuation model to estimate CoolTech’scommon stockvalue per share.b. Judging on the basis of your finding in part a and thestock’s offering price,should you buy the stock?c. On further analysis, you find that the growth rate in FCFbeyond 2019 will be3% rather than 2%. What effect would this finding have on yourresponses inparts a and b?