Assume that it is the end of year 2015 and you have an opportunity to buy the st
ID: 2784679 • Letter: A
Question
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 $9.31per 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.
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 2019 will be 44% rather than 33%.
What effect would this finding have on your responses in parts a and b?
(Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Free cash flow Year (t) 2016 2017 2018 2019 FCF $650,000 | Growth rate of FCF. beyond 2019 to infinity = 3% $750,000 | Weighted average cost of capital 14% $840,000Market value of all debt $1,560,000 $990,000Market value of preferred stock $620,000 Number of shares of common stock to be issued 1,100,000Explanation / Answer
b. Value of the firm = present value of all free cash flows
= 650,000/1.14 + 750,000/1.14^2 + 840,000/1.14^3 + 990,000/1.14^4 + [990,000*1.03/(14% - 3%)]/1.14^4
= $7,788,995.80
This is the value of the firm. Value of equity = value of firm - value of debt - value of preferred shares
= $7,788,995.80 - 1,560,000 - 620,000
= $5,608,995.80
Value of 1 stock price = value of equity/no. of shares being issued = $5,608,995.80/1,100,000
= $5.10
As the intrinsic value of 1 stock ($5.10) is < the offer price of $9.31 per share you should not buy the stock.
c. If growth rate becomes 4% instead of 3% (in the image it is given as 3% and not 33% as in "c") then value of firm = 650,000/1.14 + 750,000/1.14^2 + 840,000/1.14^3 + 990,000/1.14^4 + [990,000*1.04/(14% - 4%)]/1.14^4
= $8,396,470.17
Value of equity = value of firm - value of debt - value of preferred shares = $8,396,470.17 - 1,560,000 - 620,000 = $6,216,470.17
Thus value of 1 stock = 6,216,470.17/1,100,000 = $5.65
Thus my answer will be the same i.e. you should not buy the stock as in this case also intrinsic value (5.65) is < offer price of 9.31