# Costco Wholesale Corp. (COST)

## Present Value of Free Cash Flow to Equity (FCFE)

Difficulty: Intermediate

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 Summary)

Costco Wholesale Corp., 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 11.31%
01 FCFE0 2,719
1 FCFE1 2,783  = 2,719 × (1 + 2.37%) 2,501
2 FCFE2 2,894  = 2,783 × (1 + 3.99%) 2,336
3 FCFE3 3,057  = 2,894 × (1 + 5.61%) 2,217
4 FCFE4 3,278  = 3,057 × (1 + 7.23%) 2,135
5 FCFE5 3,568  = 3,278 × (1 + 8.85%) 2,088
5 Terminal value (TV5) 158,178  = 3,568 × (1 + 8.85%) ÷ (11.31%8.85%) 92,584
Intrinsic value of Costco Wholesale Corp.’s common stock 103,862
Intrinsic value of Costco Wholesale Corp.’s common stock (per share) \$236.16
Current share price \$274.10

Based on: 10-K (filing date: 2018-10-26).

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 1.91% Expected rate of return on market portfolio2 E(RM) 11.86% Systematic risk (β) of Costco Wholesale Corp.’s common stock βCOST 0.94 Required rate of return on Costco Wholesale Corp.’s common stock3 rCOST 11.31%

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 rCOST = RF + βCOST [E(RM) – RF]
= 1.91% + 0.94 [11.86%1.91%]
= 11.31%

### FCFE Growth Rate (g)

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

Costco Wholesale Corp., PRAT model

Average Sep 2, 2018 Sep 3, 2017 Aug 28, 2016 Aug 30, 2015 Aug 31, 2014 Sep 1, 2013
Selected Financial Data (USD \$ in millions)
Cash dividends declared 939  3,945  746  2,865  584  3,560
Net income attributable to Costco 3,134  2,679  2,350  2,377  2,058  2,039
Net sales 138,434  126,172  116,073  113,666  110,212  102,870
Total assets 40,830  36,347  33,163  33,440  33,024  30,283
Total Costco stockholders’ equity 12,799  10,778  12,079  10,617  12,303  10,833
Ratios
Retention rate1 0.70 -0.47 0.68 -0.21 0.72 -0.75
Profit margin2 2.26% 2.12% 2.02% 2.09% 1.87% 1.98%
Asset turnover3 3.39 3.47 3.50 3.40 3.34 3.40
Financial leverage4 3.19 3.37 2.75 3.15 2.68 2.80
Averages
Retention rate 0.11
Profit margin 2.06%
Asset turnover 3.42
Financial leverage 2.99
Growth rate of FCFE (g)5 2.37%

Based on: 10-K (filing date: 2018-10-26), 10-K (filing date: 2017-10-18), 10-K (filing date: 2016-10-12), 10-K (filing date: 2015-10-14), 10-K (filing date: 2014-10-15), 10-K (filing date: 2013-10-16).

2018 Calculations

1 Retention rate = (Net income attributable to Costco – Cash dividends declared) ÷ Net income attributable to Costco
= (3,134939) ÷ 3,134 = 0.70

2 Profit margin = 100 × Net income attributable to Costco ÷ Net sales
= 100 × 3,134 ÷ 138,434 = 2.26%

3 Asset turnover = Net sales ÷ Total assets
= 138,434 ÷ 40,830 = 3.39

4 Financial leverage = Total assets ÷ Total Costco stockholders’ equity
= 40,830 ÷ 12,799 = 3.19

5 g = Retention rate × Profit margin × Asset turnover × Financial leverage
= 0.11 × 2.06% × 3.42 × 2.99 = 2.37%

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

g = 100 × (Equity market value0 × r – FCFE0) ÷ (Equity market value0 + FCFE0)
= 100 × (120,546 × 11.31%2,719) ÷ (120,546 + 2,719) = 8.85%

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

#### FCFE growth rate (g) forecast

Costco Wholesale Corp., H-model

Year Value gt
1 g1 2.37%
2 g2 3.99%
3 g3 5.61%
4 g4 7.23%
5 and thereafter g5 8.85%

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)
= 2.37% + (8.85%2.37%) × (2 – 1) ÷ (5 – 1) = 3.99%

g3 = g1 + (g5g1) × (3 – 1) ÷ (5 – 1)
= 2.37% + (8.85%2.37%) × (3 – 1) ÷ (5 – 1) = 5.61%

g4 = g1 + (g5g1) × (4 – 1) ÷ (5 – 1)
= 2.37% + (8.85%2.37%) × (4 – 1) ÷ (5 – 1) = 7.23%