# Diageo PLC (DEO) | Present Value of Free Cash Flow to Equity (FCFE)

In discounted cash flow (DCF) valuation techniques the value of the stock is estimated based upon present value of some measure of cash flow. Free cash flow to equity (FCFE) is generally described as cash flows available to the equity holder after payments to debt holders and after allowing for expenditures to maintain the company's asset base.

## Intrinsic Stock Value (Valuation Summery)

Diageo PLC, free cash flow to equity (FCFE) forecast

USD \$ in millions, except per share data

Year Value FCFEt or Terminal value (TVt) Calculation Present value at 10.21%
01 FCFE0 3,513
1 FCFE1 4,154  = 3,513 × (1 + 18.26%) 3,769
2 FCFE2 4,784  = 4,154 × (1 + 15.16%) 3,939
3 FCFE3 5,361  = 4,784 × (1 + 12.06%) 4,005
4 FCFE4 5,841  = 5,361 × (1 + 8.96%) 3,959
5 FCFE5 6,183  = 5,841 × (1 + 5.85%) 3,803
5 Terminal value (TV5) 150,267  = 6,183 × (1 + 5.85%) ÷ (10.21% – 5.85%) 92,416
Intrinsic value of 's common stock 111,891

Intrinsic value of 's common stock (per share) \$162.51
Current share price \$123.99

Disclaimer!
Valuation is based on standard assumptions. There may exist specific factors relevant to stock value and omitted here. In such a case, the real stock value may differ significantly form the estimated. If you want to use the estimated intrinsic stock value in investment decision making process, do so at your own risk.

## Required Rate of Return (r)

 Assumptions Rate of return on LT Treasury Composite1 RF 2.78% Expected rate of return on market portfolio2 E(RM) 13.09% Systematic risk (β) of 's common stock βDEO 0.72 Required rate of return on 's common stock3 rDEO 10.21%

1 Unweighted average of bid yields on all outstanding fixed-coupon U.S. Treasury bonds neither due or callable in less than 10 years (risk-free rate of return proxy).

Calculations

3 rDEO = RF + βDEO [E(RM) – RF]
= 2.78% + 0.72 [13.09% – 2.78%]
= 10.21%

## FCFE Growth Rate (g)

### FCFE growth rate (g) implied by PRAT model

Diageo PLC, PRAT model

Average Jun 30, 2012 Jun 30, 2011 Jun 30, 2010 Jun 30, 2009 Jun 30, 2008 Jun 30, 2007
Selected Financial Data (USD \$ in millions, translated from GBP £)
Dividends paid   1,685  1,512  1,407  1,407  1,253  1,702
Profit for the year attributable to equity shareholders of the parent company   3,158  2,952  2,507  2,621  2,224  2,954
Sales   23,734  20,559  19,945  19,859  15,560  19,677
Total assets   36,347  30,729  29,943  29,258  23,431  27,690
Equity attributable to equity shareholders of the parent company   9,088  8,149  6,167  5,208  5,114  7,881
Ratios
Retention rate1   0.47 0.49 0.44 0.46 0.44 0.42
Profit margin2   13.31% 14.36% 12.57% 13.20% 14.29% 15.01%
Asset turnover3   0.65 0.67 0.67 0.68 0.66 0.71
Financial leverage4   4.00 3.77 4.86 5.62 4.58 3.51
Averages
Retention rate 0.45
Profit margin 13.79%
Asset turnover 0.67
Financial leverage 4.39

Growth rate of FCFE (g)5 18.26%

2012 Calculations

1 Retention rate = (Profit for the year attributable to equity shareholders of the parent company – Dividends paid) ÷ Profit for the year attributable to equity shareholders of the parent company
= (3,158 – 1,685) ÷ 3,158 = 0.47

2 Profit margin = 100 × Profit for the year attributable to equity shareholders of the parent company ÷ Sales
= 100 × 3,158 ÷ 23,734 = 13.31%

3 Asset turnover = Sales ÷ Total assets
= 23,734 ÷ 36,347 = 0.65

4 Financial leverage = Total assets ÷ Equity attributable to equity shareholders of the parent company
= 36,347 ÷ 9,088 = 4.00

5 g = Retention rate × Profit margin × Asset turnover × Financial leverage
= 0.45 × 13.79% × 0.67 × 4.39 = 18.26%

### FCFE growth rate (g) implied by single-stage model

g = 100 × (Equity market value0 × r – FCFE0) ÷ (Equity market value0 + FCFE0)
= 100 × (85,371 × 10.21% – 3,513) ÷ (85,371 + 3,513) = 5.85%

where:
Equity market value0 = current market value of 's common stock (USD \$ in millions)
FCFE0 = last year 's free cash flow to equity (USD \$ in millions)
r = required rate of return on 's common stock

### FCFE growth rate (g) forecast

Diageo PLC, H-model

Year Value gt
1 g1 18.26%
2 g2 15.16%
3 g3 12.06%
4 g4 8.96%
5 and thereafter g5 5.85%

where:
g1 is implied by PRAT model
g5 is implied by single-stage model
g2, g3 and g4 are calculated using linear interpoltion between g1 and g5

Calculations

g2 = g1 + (g5g1) × (2 – 1) ÷ (5 – 1)
= 18.26% + (5.85% – 18.26%) × (2 – 1) ÷ (5 – 1) = 15.16%

g2 = g1 + (g5g1) × (3 – 1) ÷ (5 – 1)
= 18.26% + (5.85% – 18.26%) × (3 – 1) ÷ (5 – 1) = 12.06%

g2 = g1 + (g5g1) × (4 – 1) ÷ (5 – 1)
= 18.26% + (5.85% – 18.26%) × (4 – 1) ÷ (5 – 1) = 8.96%