Question 1:
Free Cash Flow Valuation – Practice Problem
Orion Systems is preparing to go public and wants to estimate the value of its common equity
using the free cash flow valuation model. The CFO has compiled the following data:
● Weighted Average Cost of Capital (WACC): 10%
● Market Value of Debt: $1,800,000
● Market Value of Preferred Stock: $500,000
The estimated free cash flows for the next five years (2026–2030) are:
Year (t) Free Cash Flow (FCF)
2026 $220,000
2027 $270,000
2028 $320,000
2029 $370,000
2030 $420,000
Beyond 2030, Orion Systems expects its free cash flow to grow at a constant rate of 4%
annually.
Questions:
a. Estimate the value of Orion Systems’ entire company using the free cash flow valuation
model.
b. Use your result from part a, along with the data above, to calculate the value of Orion
Systems’ common equity.
c. If the firm plans to issue 250,000 shares of common stock, what is its estimated value per
share?
Question 2:
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 valuation model.
● Weighted Average Cost of Capital (WACC): 11%
● Market Value of Debt: $1,500,000
● Market Value of Preferred Stock: $400,000
The estimated free cash flows over the next 5 years, 2013 through 2017, are given below.
Beyond 2017 to infinity, the firm expects its free cash flow to grow by 3% annually.
Year (t) Free Cash Flow (FCF)
2013 $200,000
2014 $250,000
2015 $310,000
2016 $310,000
2017 $390,000
Questions:
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 stock, what is its estimated value per
share?
Question3:
Assume that you have an opportunity to buy the stock of TechNova Solutions, an IPO being
offered for $15.75 per share. Although you're excited about the potential of owning the
company, you're concerned about whether the stock is fairly priced. To determine the value of
the shares, you've decided to apply the free cash flow valuation model using financial data
compiled from various sources. The key values are summarized in the following table.
Year (t) FCF
2020 $950,000
2021 $1,050,00
2022 $1,200,00
2023 $1,350,00
📌 Additional Information
● Growth rate of FCF beyond 2023 to infinity: 3%
● Weighted average cost of capital (WACC): 9%
● Market value of all debt: $3,200,000
● Market value of preferred stock: $500,000
● Number of shares of common stock outstanding: 1,250,000
❓ Questions
1. Use the free cash flow valuation model to estimate TechNova’s common stock value per
share.
2. Based on your result in part a and the IPO offering price, would you buy the stock?
3. If further analysis reveals that the growth rate in FCF beyond 2023 will be greater than
3%, how would that affect your decision in part b?
Question4:
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. 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
have developed from a variety of data sources. The key values you have
compiled are summarized in the following table.
Free Cash Flow Table:
Year (t) FCF
2013 $700,000
2014 $800,000
2015 $900,000
2016 $1,000,00
0
Additional Information:
● Growth rate of FCF beyond 2016 to infinity: 2%
● Weighted average cost of capital (WACC): 8%
● Market value of all debt: $2,700,000
● Market value of preferred stock: $0
● Number of shares of common stock outstanding: 1,100,000
Questions:
1. Use the free cash flow valuation model to estimate CoolTech’s common stock value per
share.
2. Judging on the basis of your finding in part a and the stock’s offering price, do you buy
the stock?
3. If further analysis reveals that the growth rate in FCF beyond 2016 will be greater than
2%, what effect would this finding have on your response in part b?
Question5:
Item Year 1 Year 2 Year 3 Year 4
Net Income $800,00 $850,00 $925,00 $975,00
0 0 0 0
Depreciation $200,00 $250,00 $225,00 $275,00
0 0 0 0
Capital Expenditures $300,00 $100,00 $400,00 $300,00
0 0 0 0
Increase in Net WC -$50,000 $100,00 -$75,000 $125,00
0 0
New Debt $150,00 $75,000 $100,00 $50,000
0 0
Debt Paid $100,00 $100,00 $150,00 $125,00
0 0 0 0
📌 Additional Assumptions
● Shares Outstanding: 500,000
● Beta: 1.30
● Constant Growth After Year 4: 5%
● Expected Market Return: 10%
● Risk-Free Rate: 4%!
question6: Forecasting & Valuation Setup
Assume you’ve forecasted the following for Firm Y:
● Shares Outstanding → 600,000
● Beta → 1.15
● Constant Growth After Year 4 → 4.5%
● Expected Market Return → 11%
● Risk-Free Rate → 3.5%
Year 1 Year 2 Year 3 Year 4
Net Income $900,00 $950,00 $1,000,00 $1,050,00
0 0 0 0
Depreciation $180,00 $200,00 $220,000 $240,000
0 0
Capital Expenditures $250,00 $300,00 $350,000 $400,000
0 0
Increase in NC WC $75,000 $50,000 $100,000 $125,000
New Debt $100,00 $150,00 $125,000 $100,000
0 0
Debt Paid $80,000 $100,00 $150,000 $175,000
0
question7:
Assume the following for Firm Z:
● Shares Outstanding → 750,000
● Beta → 1.40
● Constant Growth After Year 4 → 6%
● Expected Market Return → 12%
● Risk-Free Rate → 5%
Year 1 Year 2 Year 3 Year 4
Net Income $1,200,00 $1,300,00 $1,400,00 $1,500,00
0 0 0 0
Depreciation $300,000 $320,000 $340,000 $360,000
Capital Expenditures $400,000 $450,000 $500,000 $550,000
Increase in NC WC -$25,000 $75,000 $50,000 $100,000
New Debt $200,000 $150,000 $100,000 $50,000
Debt Paid $100,000 $125,000 $150,000 $175,000
