# Northrop Grumman Corp. (NOC)

## 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)

Northrop Grumman Corp., 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 9.66%
01 FCFE0 180
1 FCFE1 225  = 180 × (1 + 24.79%) 205
2 FCFE2 272  = 225 × (1 + 20.93%) 226
3 FCFE3 318  = 272 × (1 + 17.07%) 241
4 FCFE4 360  = 318 × (1 + 13.21%) 249
5 FCFE5 394  = 360 × (1 + 9.35%) 248
5 Terminal value (TV5) 140,675  = 394 × (1 + 9.35%) ÷ (9.66%9.35%) 88,731
Intrinsic value of Northrop Grumman Corp.’s common stock 89,900

Intrinsic value of Northrop Grumman Corp.’s common stock (per share) \$533.43
Current share price \$381.64

Based on: 10-K (filing date: 2019-01-31).

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 2.07% Expected rate of return on market portfolio2 E(RM) 11.21% Systematic risk of Northrop Grumman Corp.’s common stock βNOC 0.83 Required rate of return on Northrop Grumman Corp.’s common stock3 rNOC 9.66%

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 rNOC = RF + βNOC [E(RM) – RF]
= 2.07% + 0.83 [11.21%2.07%]
= 9.66%

### FCFE Growth Rate (g)

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

Northrop Grumman Corp., PRAT model

Average Dec 31, 2018 Dec 31, 2017 Dec 31, 2016 Dec 31, 2015 Dec 31, 2014
Selected Financial Data (US\$ in millions)
Dividends declared 822  687  633  596  578
Net earnings 3,229  2,015  2,200  1,990  2,069
Sales 30,095  25,803  24,508  23,526  23,979
Total assets 37,653  34,917  25,614  24,454  26,572
Shareholders’ equity 8,187  7,048  5,259  5,522  7,235
Financial Ratios
Retention rate1 0.75 0.66 0.71 0.70 0.72
Profit margin2 10.73% 7.81% 8.98% 8.46% 8.63%
Asset turnover3 0.80 0.74 0.96 0.96 0.90
Financial leverage4 4.60 4.95 4.87 4.43 3.67
Averages
Retention rate 0.71
Profit margin 8.92%
Asset turnover 0.87
Financial leverage 4.50

FCFE growth rate (g)5 24.79%

Based on: 10-K (filing date: 2019-01-31), 10-K (filing date: 2018-01-29), 10-K (filing date: 2017-01-30), 10-K (filing date: 2016-02-01), 10-K (filing date: 2015-02-02).

2018 Calculations

1 Retention rate = (Net earnings – Dividends declared) ÷ Net earnings
= (3,229822) ÷ 3,229 = 0.75

2 Profit margin = 100 × Net earnings ÷ Sales
= 100 × 3,229 ÷ 30,095 = 10.73%

3 Asset turnover = Sales ÷ Total assets
= 30,095 ÷ 37,653 = 0.80

4 Financial leverage = Total assets ÷ Shareholders’ equity
= 37,653 ÷ 8,187 = 4.60

5 g = Retention rate × Profit margin × Asset turnover × Financial leverage
= 0.71 × 8.92% × 0.87 × 4.50 = 24.79%

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

g = 100 × (Equity market value0 × r – FCFE0) ÷ (Equity market value0 + FCFE0)
= 100 × (64,319 × 9.66%180) ÷ (64,319 + 180) = 9.35%

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

#### FCFE growth rate (g) forecast

Northrop Grumman Corp., H-model

Year Value gt
1 g1 24.79%
2 g2 20.93%
3 g3 17.07%
4 g4 13.21%
5 and thereafter g5 9.35%

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)
= 24.79% + (9.35%24.79%) × (2 – 1) ÷ (5 – 1) = 20.93%

g3 = g1 + (g5g1) × (3 – 1) ÷ (5 – 1)
= 24.79% + (9.35%24.79%) × (3 – 1) ÷ (5 – 1) = 17.07%

g4 = g1 + (g5g1) × (4 – 1) ÷ (5 – 1)
= 24.79% + (9.35%24.79%) × (4 – 1) ÷ (5 – 1) = 13.21%