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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)

Time Warner Inc., free cash flow to the firm (FCFF) forecast

USD $ in millions, except per share data

Microsoft Excel LibreOffice Calc
Year Value FCFFt or Terminal value (TVt) Calculation Present value at 9.81%
01 FCFF0 5,498 
1 FCFF1 5,816  = 5,498  × (1 + 5.78%) 5,296 
2 FCFF2 6,130  = 5,816  × (1 + 5.39%) 5,083 
3 FCFF3 6,436  = 6,130  × (1 + 5.00%) 4,860 
4 FCFF4 6,733  = 6,436  × (1 + 4.61%) 4,630 
5 FCFF5 7,018  = 6,733  × (1 + 4.23%) 4,395 
5 Terminal value (TV5) 130,949  = 7,018  × (1 + 4.23%) ÷ (9.81% – 4.23%) 82,007 
Intrinsic value of Time Warner's capital 106,273 
Less: Debt (fair value) 25,327 
Intrinsic value of Time Warner's common stock 80,946 
Intrinsic value of Time Warner's common stock (per share) $103.47
Current share price $98.77

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)

Time Warner Inc., cost of capital

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Value1 Weight Required rate of return2 Calculation
Equity (fair value) 77,270  0.75 11.94%
Debt (fair value) 25,327  0.25 3.31% = 4.32% × (1 – 23.36%)

1 USD $ in millions

   Equity (fair value) = No. shares of common stock outstanding × Current share price
= 782,319,431 × $98.77 = $77,269,690,199.87

   Debt (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
= (11.79% + 25.00% + 30.00% + 17.00% + 33.00%) ÷ 5 = 23.36%

WACC = 9.81%


FCFF Growth Rate (g)

FCFF growth rate (g) implied by PRAT model

Time Warner Inc., PRAT model

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Average Dec 31, 2017 Dec 31, 2016 Dec 31, 2015 Dec 31, 2014 Dec 31, 2013
Selected Financial Data (USD $ in millions)
Interest expense 1,214  1,388  1,382  1,353  1,283 
Discontinued operations, net of tax 11  37  (67) 137 
Net income attributable to Time Warner Inc. shareholders 5,247  3,926  3,833  3,827  3,691 
Effective income tax rate (EITR)1 11.79% 25.00% 30.00% 17.00% 33.00%
Interest expense, after tax2 1,071  1,041  967  1,123  860 
Add: Cash dividends 1,583  1,269  1,150  1,109  1,074 
Interest expense (after tax) and dividends 2,654  2,310  2,117  2,232  1,934 
EBIT(1 – EITR)3 6,318  4,956  4,763  5,017  4,414 
Debt due within one year 5,450  1,947  198  1,118  66 
Long-term debt, excluding due within one year 18,294  22,392  23,594  21,376  20,099 
Total Time Warner Inc. shareholders' equity 28,375  24,335  23,619  24,476  29,904 
Total capital 52,119  48,674  47,411  46,970  50,069 
Ratios
Retention rate (RR)4 0.58 0.53 0.56 0.56 0.56
Return on invested capital (ROIC)5 12.12% 10.18% 10.05% 10.68% 8.82%
Averages
RR 0.56
ROIC 10.37%
Growth rate of FCFF (g)6 5.78%

2017 Calculations

2 Interest expense, after tax = Interest expense × (1 – EITR)
= 1,214 × (1 – 11.79%) = 1,071

3 EBIT(1 – EITR) = Net income attributable to Time Warner Inc. shareholders – Discontinued operations, net of tax + Interest expense, after tax
= 5,247 + 1,071 = 6,318

4 RR = [EBIT(1 – EITR) – Interest expense (after tax) and dividends] ÷ EBIT(1 – EITR)
= [6,3182,654] ÷ 6,318 = 0.58

5 ROIC = 100 × EBIT(1 – EITR) ÷ Total capital
= 100 × 6,318 ÷ 52,119 = 12.12%

6 g = RR × ROIC
= 0.56 × 10.37% = 5.78%


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

g = 100 × (Total capital, fair value0 × WACC – FCFF0) ÷ (Total capital, fair value0 + FCFF0)
= 100 × (102,597 × 9.81% – 5,498) ÷ (102,597 + 5,498) = 4.23%

where:
Total capital, fair value0 = current fair value of Time Warner's debt and equity (USD $ in millions)
FCFF0 = last year Time Warner's free cash flow to the firm (USD $ in millions)
WACC = weighted average cost of Time Warner's capital


FCFF growth rate (g) forecast

Time Warner Inc., H-model

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Year Value gt
1 g1 5.78%
2 g2 5.39%
3 g3 5.00%
4 g4 4.61%
5 and thereafter g5 4.23%

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)
= 5.78% + (4.23% – 5.78%) × (2 – 1) ÷ (5 – 1) = 5.39%

g3 = g1 + (g5g1) × (3 – 1) ÷ (5 – 1)
= 5.78% + (4.23% – 5.78%) × (3 – 1) ÷ (5 – 1) = 5.00%

g4 = g1 + (g5g1) × (4 – 1) ÷ (5 – 1)
= 5.78% + (4.23% – 5.78%) × (4 – 1) ÷ (5 – 1) = 4.61%