Assume that you have started a business three years ago and had invested $200,00
ID: 2801318 • Letter: A
Question
Assume that you have started a business three years ago and had invested $200,000 for the startup cost. After three years, your company becomes so successful that you want to take your company public by issuing 10,000 shares of common stock for yourself and sell 90,000 shares to the general public. Your company is expected to generate $100,000 starting one year from the day of the Initial Public Offering (IPO) for the next 5 years and the cash flows are expected to grow at annual rate of 5%. At the end of the fifth year the company will sell all its assets for $50,000 and cease to exist. What would be the stock price on the day of the IPO if the interest rate is 6%?
Explanation / Answer
The discounted cash flows are used to determine the PW of the business as follows
Discounted cash flow= Cah flow*1/1.06^n
PW of the business on the date of IPO = 500244.60
Number of shares to be issued = 100000
Hence price of shares = 500244.6/ 100000 = $5.0024
Year Cash flows Sale of assets Net cash flows Discounted cash flows 1 100000 100000 94339.62 2 105000 105000 93449.63 3 110250 110250 92568.03 4 115762.5 115762.5 91694.74 5 121550.6 50000 171550.6 128192.6 PW 500244.6