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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 $$6\mathrm{.}75$ 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,

Free Cash Flow

Year $($t$)$ FCF Other data

$1$ $$720,000$ Growth rate of FCF$,$ beyond year $4=3\%$

$2$ $$860,000$ Weighted average cost of capital $=9\%$

$3$ $$1,000,000$ Market value of all debt $=$ $$3,370,000$

$4$ $$1,140,000$ Market value of preferred stock $=$ $$1,350,000$ & Number of shares of common stock outstanding $=1,100,000$

Questions:

a$)$ Use the free cash flow valuation model to estimate CoolTech's common stock value per share.

b$)$ Judging by your findings 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 year $4$ will be $4\%$ rather than $3\%.$ What effect would this finding have on your responses in parts a and b$?$

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