# Zoetis Inc. (NYSE:ZTS)

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

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

### Intrinsic Stock Value (Valuation Summary)

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

US\$ in millions, except per share data

Year Value FCFFt or Terminal value (TVt) Calculation Present value at 9.13%
01 FCFF0 1,552
1 FCFF1 1,697  = 1,552  × (1 + 9.37%) 1,555
2 FCFF2 1,845  = 1,697  × (1 + 8.74%) 1,549
3 FCFF3 1,995  = 1,845  × (1 + 8.10%) 1,535
4 FCFF4 2,143  = 1,995  × (1 + 7.46%) 1,511
5 FCFF5 2,290  = 2,143  × (1 + 6.82%) 1,479
5 Terminal value (TV5) 105,804  = 2,290  × (1 + 6.82%) ÷ (9.13%6.82%) 68,360
Intrinsic value of Zoetis Inc.’s capital 75,990
Less: Debt (fair value) 6,587
Intrinsic value of Zoetis Inc.’s common stock 69,403

Intrinsic value of Zoetis Inc.’s common stock (per share) \$146.13
Current share price \$137.10

Based on: 10-K (filing date: 2020-02-13).

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)

Zoetis Inc., cost of capital

Value1 Weight Required rate of return2 Calculation
Equity (fair value) 65,114  0.91 9.78%
Debt (fair value) 6,587  0.09 2.73% = 3.84% × (1 – 28.90%)

Based on: 10-K (filing date: 2020-02-13).

1 US\$ in millions

Equity (fair value) = No. shares of common stock outstanding × Current share price
= 474,940,772 × \$137.10 = \$65,114,379,841.20

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
= (16.70% + 20.90% + 35.80% + 33.30% + 37.80%) ÷ 5 = 28.90%

WACC = 9.13%

### FCFF Growth Rate (g)

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

Zoetis 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)
Interest expense, net of capitalized interest 223  206  175  166  124
Net income attributable to Zoetis 1,500  1,428  864  821  339

Effective income tax rate (EITR)1 16.70% 20.90% 35.80% 33.30% 37.80%

Interest expense, net of capitalized interest, after tax2 186  163  112  111  77
Add: Dividends declared 330  261  216  193  172
Interest expense (after tax) and dividends 516  424  328  304  249

EBIT(1 – EITR)3 1,686  1,591  976  932  416

Short-term borrowings —  —  —
Current portion of long-term debt 500  —  —  —  400
Long-term debt, excluding current portion, net of discount and issuance costs 5,947  6,443  4,953  4,468  4,463
Total Zoetis Inc. equity 2,708  2,185  1,770  1,487  1,068
Total capital 9,155  8,637  6,723  5,955  5,936
Financial Ratios
Retention rate (RR)4 0.69 0.73 0.66 0.67 0.40
Return on invested capital (ROIC)5 18.41% 18.42% 14.52% 15.65% 7.01%
Averages
RR 0.63
ROIC 14.80%

FCFF growth rate (g)6 9.37%

Based on: 10-K (filing date: 2020-02-13), 10-K (filing date: 2019-02-14), 10-K (filing date: 2018-02-15), 10-K (filing date: 2017-02-16), 10-K (filing date: 2016-02-24).

2019 Calculations

2 Interest expense, net of capitalized interest, after tax = Interest expense, net of capitalized interest × (1 – EITR)
= 223 × (1 – 16.70%) = 186

3 EBIT(1 – EITR) = Net income attributable to Zoetis + Interest expense, net of capitalized interest, after tax
= 1,500 + 186 = 1,686

4 RR = [EBIT(1 – EITR) – Interest expense (after tax) and dividends] ÷ EBIT(1 – EITR)
= [1,686516] ÷ 1,686 = 0.69

5 ROIC = 100 × EBIT(1 – EITR) ÷ Total capital
= 100 × 1,686 ÷ 9,155 = 18.41%

6 g = RR × ROIC
= 0.63 × 14.80% = 9.37%

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

g = 100 × (Total capital, fair value0 × WACC – FCFF0) ÷ (Total capital, fair value0 + FCFF0)
= 100 × (71,701 × 9.13%1,552) ÷ (71,701 + 1,552) = 6.82%

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

#### FCFF growth rate (g) forecast

Zoetis Inc., H-model

Year Value gt
1 g1 9.37%
2 g2 8.74%
3 g3 8.10%
4 g4 7.46%
5 and thereafter g5 6.82%

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)
= 9.37% + (6.82%9.37%) × (2 – 1) ÷ (5 – 1) = 8.74%

g3 = g1 + (g5g1) × (3 – 1) ÷ (5 – 1)
= 9.37% + (6.82%9.37%) × (3 – 1) ÷ (5 – 1) = 8.10%

g4 = g1 + (g5g1) × (4 – 1) ÷ (5 – 1)
= 9.37% + (6.82%9.37%) × (4 – 1) ÷ (5 – 1) = 7.46%