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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.
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Free cash flow
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Year (t)
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FCFt
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Other data
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2013
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$700,000
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Growth rate of FCF, beyond 2013 to infinity 2%
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2014
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800,000
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Weighted average cost of capital = 8%
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2015
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950,000
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Market value of all debt = $2,700,000
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2016
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1,100,000
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Market value of preferred stock = $1,000,000
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Number of shares of common stock outstanding = 1,100,000
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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?
