Principles of Managerial Finance

CHAPTER 7 Stock Valuation 345

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7–16 Free cash flow valuation Nabor Industries is considering going public but is

unsure of a fair offering price for the company. Before hiring an investment

banker to assist in making the public offering, managers at Nabor have decided

to make their own estimate of the firm’s common stock value. The firm’s CFO

has gathered data for performing the valuation using the free cash flow valua-

tion model.

The firm’s weighted average cost of capital is 11%, and it has $1,500,000 of

debt at market value and $400,000 of preferred stock at its assumed market

value. The estimated free cash flows over the next 5 years, 2004 through 2008,

are given below. Beyond 2008 to infinity, the firm expects its free cash flow to

grow by 3% annually.

a. Estimate the value of Nabor Industries’ entire company by using the free cash

flow valuation model.

b. Use your finding in part a,along with the data provided above, to find Nabor

Industries’ common stock value.

c. If the firm plans to issue 200,000 shares of common sock, what is its esti-

mated value per share?

7–17 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 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. In order 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.

a. Use the free cash flow valuation modelto estimate CoolTech’s common stock

value per share.

b. Judging on the basis of your finding in part aand the stock’s offering price,

should you buy the stock?

Free cash flow

Year (t) FCFt Other data

2004 $ 700,000 Growth rate of FCF, beyond 2007 to infinity2%

2005 800,000 Weighted average cost of capital8%

2006 950,000 Market value of all debt$2,700,000

2007 1,100,000 Market value of preferred stock$1,000,000

Number of shares of common stock outstanding1,100,000

Year (t) Free cash flow (FCFt)

2004 $200,000

2005 250,000

2006 310,000

2007 350,000

2008 390,000