Using the free cash flow valuation model to price an IPO Personal Finance Proble
ID: 2771940 • Letter: U
Question
Using the free cash flow valuation model to price an IPO Personal Finance Problem Assume that it is the end of year 2015 and you have an opportunity to buy the stock of CoolTech, Inc., an IPO being offered for $10.01 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, Use the free cash flow valuation model to estimate CoolTech's common stock value per share. Judging on the basis of your finding in part a and the stock's offering price, should you buy the stock? On further analysis, you find that the growth rate in FCF beyond 2019 will be 6% rather than 5%. What effect would this finding have on your responses in parts a and b?Explanation / Answer
Part A.
Years
FCFF
PV of FCFF = FCFF/(1+WACC)^t
1
2016
$ 740,000
$ 649,122.81
2
2017
$ 860,000
$ 661,742.07
3
2018
$ 940,000
$ 634,473.23
4
2019
$ 1,090,000
$ 645,367.50
4
Beyond 2019
$ 12,716,667
$ 7,529,287.72
Total Present Value of FCFF
$ 10,119,993.14
Total Business Value=
$ 10,119,993.14
Equity Value Under FCFF Valuation Model = Total Business Value Market Value of Debt- Market value of Preferred stock=
$ 7,289,993.14
Intrinsic Value per share = Equity Value Under FCFF Valuation Model/No. of common shares outstanding=
$ 6.63
Part B. As per the Discounted FCF model, CoolTech’s common stock value per share is $6.63 and the IPO is being offered at $10.1 per share which is more than the intrinsic value. Since the IPO has been overvalued, I would not buy the stock.
Part C. Growth rate beyond 2019 is 6%
Part C.
Years
FCFF
PV of FCFF = FCFF/(1+WACC)^t
1
2016
$ 740,000
$ 649,122.81
2
2017
$ 860,000
$ 661,742.07
3
2018
$ 940,000
$ 634,473.23
4
2019
$ 1,090,000
$ 645,367.50
4
Beyond 2019
$ 14,442,500
$ 8,551,119.41
Total PV of FCFF
$ 11,141,825.01
Total Business Value
$ 11,141,825.01
Equity Value Under FCFF Valuation Model = Total Business Value Market Value of Debt- Market value of Preferred stock
$ 8,311,825.01
Intrinsic Value per share = Equity Value Under FCFF Valuation Model/No. of common shares outstanding
$ 7.56
For growth rate of 6% beyond 2019, CoolTech’s common stock value per share is $7.56 which is more than the value per share of $6.63 when the growth rate was less at 5%. However, the price per share offered under the IPO i.e. $10.1 is still more than the intrinsic value of $7.56. Ergo, I would not buy the shares.
Part A.
Years
FCFF
PV of FCFF = FCFF/(1+WACC)^t
1
2016
$ 740,000
$ 649,122.81
2
2017
$ 860,000
$ 661,742.07
3
2018
$ 940,000
$ 634,473.23
4
2019
$ 1,090,000
$ 645,367.50
4
Beyond 2019
$ 12,716,667
$ 7,529,287.72
Total Present Value of FCFF
$ 10,119,993.14
Total Business Value=
$ 10,119,993.14
Equity Value Under FCFF Valuation Model = Total Business Value Market Value of Debt- Market value of Preferred stock=
$ 7,289,993.14
Intrinsic Value per share = Equity Value Under FCFF Valuation Model/No. of common shares outstanding=
$ 6.63
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