CHAPTER 7 Stock Valuation 269 P7-12 Using the free cash flow valuation model to
ID: 2719536 • Letter: C
Question
CHAPTER 7 Stock Valuation 269 P7-12 Using the free cash flow valuation model to price an IPO Assume that you have an opportunity to buy the stock of CoolTech, Inc., an PO being offered for US$12.50 per share. Although yoa are very much interested in owning the company, you are concerned about whether it is fairly priced-To determine the value of tht 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 Bow Year (n FCF Orber data | Growth tate of FCF. beyond 2013 io aany-2% Weghted-rage cot of capital-8% USS 700,000 2013 2014 soo,000 2015000 2016 Maket value of prefeed mock-0551 000000 1,100,000 Number od shares of common seock ountanding 1,100,000 a. Use the free cash flow valuation,model to estimate CoolTech's common stock b. Judging on the basis of your finding in part a and the stock's offering price, e. Upon further analysis, you find that the growth rate in FCF beyond 2016 will value per share. should you buy the stock? be 3 percent rather than 2 percent. What effiect would chis finding have on your responses it, parti #nd b? (4) All interest and dividends are currently paid up. (5) Land and buildings can be liquidated at 130 percent of book value. he liqnidated at 70 perceat of book valueExplanation / Answer
(a) calculation of Value of business
FCF for 2017 = 1100000x102% = 1122000
Value at the end of 2016 = 1122000/(8%-2%) =18700000
Value of business = 700000x0.926 + 800000x0.857 + 250000x0.794 + 1100000x0.735 + 18700000x0.735
= 16085300
Value per share = 16085300/1100000 = 14.62
(b) We should buy the stock since stock offered price is 12.50 which is less than 14.62 as calculated above
(c) If growth rate becomes 3% then,
FCF for 2017 = 1100000x103% = 1133000
Value at the end of 2016 = 1133000/(8%-3%) =22660000
Value of business = 700000x0.926 + 800000x0.857 + 250000x0.794 + 1100000x0.735 + 22660000x0.735
= 18995900
Value per share = 18995900/1100000 = 17.26
It inreases price per share but still the decision remains the same as offered price is still lower tha price calculated above.