Lockheed Martin Valuation Case Solution
Â Â Â Â Â Â Â Â Â Â Â Lockheed Martin faces high risks from the international manufacturer of aerospace products, as customers seek price competitive products. Reduction in the US budget spending will result in the loss of revenue however, it will only be compensated by international sales. In order to improve its position in the international market,the company would have to use advanced technology to compete with global manufacturers.
Â Â Â Â Â Â Â Â Â Â Â Adverse changes in economic environment mainly include constraints on available financing which heavily affect Lockheed Martin as the difficulties in getting finance will lead to an increase in the cost of capital as a result, it would decrease the margins and profitability.
Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Lockheed Martin is considering increasing its sales in the international market due to which, it will face local, political, legal and economic risk of different countries. Violation or non-compliance with local laws may result in huge liabilities and would affect the companyâ€™s international reputation. Local economic environment is regarding the local taxation, duties on import export, currency risk and etc. These risks will create uncertainty in the profit and growth in the future.
Valuation of LOCKHEED MARTIN
Dividend Valuation Model
Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â The fundamental value of Lockheed Martinis currently $ 285,042 million by using dividend valuation model, whereas capital asset pricing model is used to calculate the cost of equity of Lockheed Martin. Numerous assumptions were considered to calculate the cost of equity and fundamental value of Lockheed Martin.First of all, the beta equity for Lockheed Martin is taken by the article from the financial times. Secondly, the market risk free rate is assumed at 0% and the market rate is assume to be at 5%.Dividends paid previously were used to calculate average growth rate of 12% for the next four years after which it stabilizedat 2%.
Â Â Â Â Â Â Â Â Â Â Â These growth rates are accurate for Lockheed Martin as its life cycle indicates that it is going towards maturity andit is predicated that after some years, its revenue will be stabilized, which is not the case currently as the net sales are growing on a yearly basis.
Sensitivity Analysis on Dividend valuation model
Â Â Â Â Â Â Â Â Â Â Â Sensitivity analysis is performed on the discount rates to check how it will adversely affect the fundamental value of lock heed martin. The calculation shows that 1% increase in discount rate will dilute the fundamental value by 49% approximately, which indicates that the fundamental value is highly sensitive towards the changes in cost of equity.
Â Â Â Â Â Â Â Â Â Â Â There is a decrease of 1% in the growth of the company for the year 2020. It can also be seen that the fundamental value of the company has also decreased by 50% approximately, which is again too sensitive for the fundamental value of Lockheed Martin.
Free-cash flow model
By using free cash flow model, the fundamental value of Lockheed Martin is $238344 Million, which is below by $45000 million as compared to the value calculated by dividend valuation model. Previously, free cash flows were used to calculate the next four yearsâ€™ growth rate, which is 11% after which thegrowth would stabilize at 2% in the future.The cost of equity used in free cash flow model is taken from dividend valuation model which has been calculated previously. The free cash flows are calculated by taking the net earning and adding back the depreciation and then deducting the annual capital expenditure and changes in the working capital.
Sensitivity Analysis on Free cash flow model
Â Â Â Â Â Â Â Â Â Â Â Similarly as in dividend valuation model, sensitivity analysis is performed on fundamental value calculated by free cash model to check the impact on the fundamental value with the changes in discount rates and growth rates.It can be observed in the calculations that if there is a 1% increase in the cost of equity, then the fundamental value of Lockheed Martin will decrease by almost 50% which is an alarming situation for the company. On the other hand, if there is a 1% decrease in growth rate for year 2020, then as a result, the fundamental value of the company will again decrease by 50% approximately……………….
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