# Illinois Tool Works Inc. (NYSE:ITW)

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

Intermediate level

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)

Illinois Tool Works Inc., free cash flow to equity (FCFE) forecast

US\$ in millions, except per share data

Year Value FCFEt or Terminal value (TVt) Calculation Present value at 14.46%
01 FCFE0 3,116
1 FCFE1 4,005  = 3,116 × (1 + 28.52%) 3,499
2 FCFE2 4,952  = 4,005 × (1 + 23.66%) 3,780
3 FCFE3 5,883  = 4,952 × (1 + 18.79%) 3,923
4 FCFE4 6,702  = 5,883 × (1 + 13.93%) 3,905
5 FCFE5 7,310  = 6,702 × (1 + 9.06%) 3,721
5 Terminal value (TV5) 147,679  = 7,310 × (1 + 9.06%) ÷ (14.46%9.06%) 75,168
Intrinsic value of Illinois Tool Works Inc.’s common stock 93,995

Intrinsic value of Illinois Tool Works Inc.’s common stock (per share) \$297.30
Current share price \$199.11

Based on: 10-K (filing date: 2020-02-14).

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 1.27% Expected rate of return on market portfolio2 E(RM) 12.08% Systematic risk of Illinois Tool Works Inc.’s common stock βITW 1.22 Required rate of return on Illinois Tool Works Inc.’s common stock3 rITW 14.46%

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).

3 rITW = RF + βITW [E(RM) – RF]
= 1.27% + 1.22 [12.08%1.27%]
= 14.46%

### FCFE Growth Rate (g)

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

Illinois Tool Works Inc., PRAT model

Average Dec 31, 2019 Dec 31, 2018 Dec 31, 2017 Dec 31, 2016 Dec 31, 2015
Selected Financial Data (US\$ in millions)
Dividends declared 1,335  1,186  982  846  756
Net income 2,521  2,563  1,687  2,035  1,899
Operating revenue 14,109  14,768  14,314  13,599  13,405
Total assets 15,068  14,870  16,780  15,201  15,729
Stockholders’ equity attributable to ITW 3,026  3,254  4,585  4,254  5,224
Financial Ratios
Retention rate1 0.47 0.54 0.42 0.58 0.60
Profit margin2 17.87% 17.36% 11.79% 14.96% 14.17%
Asset turnover3 0.94 0.99 0.85 0.89 0.85
Financial leverage4 4.98 4.57 3.66 3.57 3.01
Averages
Retention rate 0.52
Profit margin 15.23%
Asset turnover 0.91
Financial leverage 3.96

FCFE growth rate (g)5 28.52%

Based on: 10-K (filing date: 2020-02-14), 10-K (filing date: 2019-02-15), 10-K (filing date: 2018-02-15), 10-K (filing date: 2017-02-10), 10-K (filing date: 2016-02-12).

2019 Calculations

1 Retention rate = (Net income – Dividends declared) ÷ Net income
= (2,5211,335) ÷ 2,521 = 0.47

2 Profit margin = 100 × Net income ÷ Operating revenue
= 100 × 2,521 ÷ 14,109 = 17.87%

3 Asset turnover = Operating revenue ÷ Total assets
= 14,109 ÷ 15,068 = 0.94

4 Financial leverage = Total assets ÷ Stockholders’ equity attributable to ITW
= 15,068 ÷ 3,026 = 4.98

5 g = Retention rate × Profit margin × Asset turnover × Financial leverage
= 0.52 × 15.23% × 0.91 × 3.96 = 28.52%

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

g = 100 × (Equity market value0 × r – FCFE0) ÷ (Equity market value0 + FCFE0)
= 100 × (62,951 × 14.46%3,116) ÷ (62,951 + 3,116) = 9.06%

where:
Equity market value0 = current market value of Illinois Tool Works Inc.’s common stock (US\$ in millions)
FCFE0 = the last year Illinois Tool Works Inc.’s free cash flow to equity (US\$ in millions)
r = required rate of return on Illinois Tool Works Inc.’s common stock

#### FCFE growth rate (g) forecast

Illinois Tool Works Inc., H-model

Year Value gt
1 g1 28.52%
2 g2 23.66%
3 g3 18.79%
4 g4 13.93%
5 and thereafter g5 9.06%

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)
= 28.52% + (9.06%28.52%) × (2 – 1) ÷ (5 – 1) = 23.66%

g3 = g1 + (g5g1) × (3 – 1) ÷ (5 – 1)
= 28.52% + (9.06%28.52%) × (3 – 1) ÷ (5 – 1) = 18.79%

g4 = g1 + (g5g1) × (4 – 1) ÷ (5 – 1)
= 28.52% + (9.06%28.52%) × (4 – 1) ÷ (5 – 1) = 13.93%