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# Time Warner Inc. (TWX)

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

Medium level of difficulty

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)

Time Warner 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 11.15%
01 FCFE0 3,668
1 FCFE1 4,052  = 3,668 × (1 + 10.47%) 3,646
2 FCFE2 4,432  = 4,052 × (1 + 9.38%) 3,587
3 FCFE3 4,800  = 4,432 × (1 + 8.29%) 3,495
4 FCFE4 5,146  = 4,800 × (1 + 7.20%) 3,371
5 FCFE5 5,460  = 5,146 × (1 + 6.12%) 3,218
5 Terminal value (TV5) 115,025  = 5,460 × (1 + 6.12%) ÷ (11.15%6.12%) 67,795
Intrinsic value of Time Warner Inc.’s common stock 85,113

Intrinsic value of Time Warner Inc.’s common stock (per share) \$108.80
Current share price \$98.77

Based on: 10-K (filing date: 2018-02-22).

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 2.28% Expected rate of return on market portfolio2 E(RM) 11.55% Systematic risk of Time Warner Inc.’s common stock βTWX 0.96 Required rate of return on Time Warner Inc.’s common stock3 rTWX 11.15%

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 rTWX = RF + βTWX [E(RM) – RF]
= 2.28% + 0.96 [11.55%2.28%]
= 11.15%

### FCFE Growth Rate (g)

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

Time Warner Inc., PRAT model

Average Dec 31, 2017 Dec 31, 2016 Dec 31, 2015 Dec 31, 2014 Dec 31, 2013
Selected Financial Data (US\$ in millions)
Cash dividends 1,583  1,269  1,150  1,109  1,074
Net income attributable to Time Warner Inc. shareholders 5,247  3,926  3,833  3,827  3,691
Revenues 31,271  29,318  28,118  27,359  29,795
Total assets 69,209  65,966  63,848  63,259  67,994
Total Time Warner Inc. shareholders’ equity 28,375  24,335  23,619  24,476  29,904
Financial Ratios
Retention rate1 0.70 0.68 0.70 0.71 0.71
Profit margin2 16.78% 13.39% 13.63% 13.99% 12.39%
Asset turnover3 0.45 0.44 0.44 0.43 0.44
Financial leverage4 2.44 2.71 2.70 2.58 2.27
Averages
Retention rate 0.70
Profit margin 13.35%
Asset turnover 0.44
Financial leverage 2.54

FCFE growth rate (g)5 10.47%

Based on: 10-K (filing date: 2018-02-22), 10-K (filing date: 2017-02-23), 10-K (filing date: 2016-02-25), 10-K (filing date: 2015-02-26), 10-K (filing date: 2014-02-26).

2017 Calculations

1 Retention rate = (Net income attributable to Time Warner Inc. shareholders – Cash dividends) ÷ Net income attributable to Time Warner Inc. shareholders
= (5,2471,583) ÷ 5,247 = 0.70

2 Profit margin = 100 × Net income attributable to Time Warner Inc. shareholders ÷ Revenues
= 100 × 5,247 ÷ 31,271 = 16.78%

3 Asset turnover = Revenues ÷ Total assets
= 31,271 ÷ 69,209 = 0.45

4 Financial leverage = Total assets ÷ Total Time Warner Inc. shareholders’ equity
= 69,209 ÷ 28,375 = 2.44

5 g = Retention rate × Profit margin × Asset turnover × Financial leverage
= 0.70 × 13.35% × 0.44 × 2.54 = 10.47%

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

g = 100 × (Equity market value0 × r – FCFE0) ÷ (Equity market value0 + FCFE0)
= 100 × (77,270 × 11.15%3,668) ÷ (77,270 + 3,668) = 6.12%

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

#### FCFE growth rate (g) forecast

Time Warner Inc., H-model

Year Value gt
1 g1 10.47%
2 g2 9.38%
3 g3 8.29%
4 g4 7.20%
5 and thereafter g5 6.12%

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)
= 10.47% + (6.12%10.47%) × (2 – 1) ÷ (5 – 1) = 9.38%

g3 = g1 + (g5g1) × (3 – 1) ÷ (5 – 1)
= 10.47% + (6.12%10.47%) × (3 – 1) ÷ (5 – 1) = 8.29%

g4 = g1 + (g5g1) × (4 – 1) ÷ (5 – 1)
= 10.47% + (6.12%10.47%) × (4 – 1) ÷ (5 – 1) = 7.20%