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Using the free cash flow valuation model to price an IPO Assume

05 / 03 / 2018 Assignment

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Using the free cash flow valuation model to price an IPO Assume that you have an opportunity to buy the stock of Cool Tech, 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





2013

$700,000

Growth rate of FCF, beyond 2013 to infinity 2%


2014

800,000

Weighted average cost of capital = 8%



2015

950,000

Market value of all debt = $2,700,000



2016

1,100,000

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




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









a. Use the free cash flow valuation model to estimate Cool Tech’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 2016 will be 3% rather than 2%. What effect would this finding have on your responses in parts a and b?


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