# Northrop Grumman Corp. (NOC)

## Present Value of Free Cash Flow to the Firm (FCFF)

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 the firm (FCFF) is generally described as cash flows after direct costs and before any payments to capital suppliers.

### Intrinsic Stock Value (Valuation Summary)

Northrop Grumman Corp., free cash flow to the firm (FCFF) forecast

USD \$ in millions, except per share data

Year Value FCFFt or Terminal value (TVt) Calculation Present value at 8.78%
01 FCFF0 2,972
1 FCFF1 3,280  = 2,972  × (1 + 10.38%) 3,015
2 FCFF2 3,574  = 3,280  × (1 + 8.96%) 3,020
3 FCFF3 3,844  = 3,574  × (1 + 7.55%) 2,986
4 FCFF4 4,080  = 3,844  × (1 + 6.14%) 2,914
5 FCFF5 4,273  = 4,080  × (1 + 4.73%) 2,806
5 Terminal value (TV5) 110,607  = 4,273  × (1 + 4.73%) ÷ (8.78%4.73%) 72,622
Intrinsic value of Northrop Grumman Corp.’s capital 87,363
Less: Long-term debt, including current portion (fair value) 14,300
Intrinsic value of Northrop Grumman Corp.’s common stock 73,063
Intrinsic value of Northrop Grumman Corp.’s common stock (per share) \$431.82
Current share price \$370.08

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.

### Weighted Average Cost of Capital (WACC)

Northrop Grumman Corp., cost of capital

Value1 Weight Required rate of return2 Calculation
Equity (fair value) 62,617  0.81 10.15%
Long-term debt, including current portion (fair value) 14,300  0.19 2.76% = 3.73% × (1 – 26.12%)

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

1 USD \$ in millions

Equity (fair value) = No. shares of common stock outstanding × Current share price
= 169,198,172 × \$370.08 = \$62,616,859,493.76

Long-term debt, including current portion (fair value). See Details »

2 Required rate of return on equity is estimated by using CAPM. See Details »

Required rate of return on debt. See Details »

Required rate of return on debt is after tax.

Estimated (average) effective income tax rate
= (13.70% + 33.90% + 24.70% + 28.70% + 29.60%) ÷ 5 = 26.12%

WACC = 8.78%

### FCFF Growth Rate (g)

#### FCFF 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 (USD \$ in millions)
Interest expense 562  360  301  301  282
Net earnings 3,229  2,015  2,200  1,990  2,069
Effective income tax rate (EITR)1 13.70% 33.90% 24.70% 28.70% 29.60%
Interest expense, after tax2 485  238  227  215  199
Add: Dividends declared 822  687  633  596  578
Interest expense (after tax) and dividends 1,307  925  860  811  777
EBIT(1 – EITR)3 3,714  2,253  2,427  2,205  2,268
Current portion of long-term debt 517  867  12  110
Long-term debt, net of current portion 13,883  14,399  7,058  6,416  5,925
Shareholders’ equity 8,187  7,048  5,259  5,522  7,235
Total capital 22,587  22,314  12,329  12,048  13,163
Ratios
Retention rate (RR)4 0.65 0.59 0.65 0.63 0.66
Return on invested capital (ROIC)5 16.44% 10.10% 19.68% 18.30% 17.23%
Averages
RR 0.63
ROIC 16.35%
Growth rate of FCFF (g)6 10.38%

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

2 Interest expense, after tax = Interest expense × (1 – EITR)
= 562 × (1 – 13.70%) = 485

3 EBIT(1 – EITR) = Net earnings + Interest expense, after tax
= 3,229 + 485 = 3,714

4 RR = [EBIT(1 – EITR) – Interest expense (after tax) and dividends] ÷ EBIT(1 – EITR)
= [3,7141,307] ÷ 3,714 = 0.65

5 ROIC = 100 × EBIT(1 – EITR) ÷ Total capital
= 100 × 3,714 ÷ 22,587 = 16.44%

6 g = RR × ROIC
= 0.63 × 16.35% = 10.38%

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

g = 100 × (Total capital, fair value0 × WACC – FCFF0) ÷ (Total capital, fair value0 + FCFF0)
= 100 × (76,917 × 8.78%2,972) ÷ (76,917 + 2,972) = 4.73%

where:
Total capital, fair value0 = current fair value of Northrop Grumman Corp.’s debt and equity (USD \$ in millions)
FCFF0 = last year Northrop Grumman Corp.’s free cash flow to the firm (USD \$ in millions)
WACC = weighted average cost of Northrop Grumman Corp.’s capital

#### FCFF growth rate (g) forecast

Northrop Grumman Corp., H-model

Year Value gt
1 g1 10.38%
2 g2 8.96%
3 g3 7.55%
4 g4 6.14%
5 and thereafter g5 4.73%

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)
= 10.38% + (4.73%10.38%) × (2 – 1) ÷ (5 – 1) = 8.96%

g3 = g1 + (g5g1) × (3 – 1) ÷ (5 – 1)
= 10.38% + (4.73%10.38%) × (3 – 1) ÷ (5 – 1) = 7.55%

g4 = g1 + (g5g1) × (4 – 1) ÷ (5 – 1)
= 10.38% + (4.73%10.38%) × (4 – 1) ÷ (5 – 1) = 6.14%