Compute the value of a share of starbucks common stock

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Reference no: EM13902263

STARBUCKS

Free Cash Flows Valuation of Starbucks' Common Equity

In Integrative Case 10.1, we projected financial statements for Starbucks for Years +1 through +5. In this portion of the Starbucks Integrative Case, we use the projected finan- cial statements from Integrative Case 10.1 and apply the techniques in Chapter 12 to com- pute Starbucks' required rate of return on equity and share value based on the free cash flows valuation model. We also compare our value estimate to Starbucks' share price at the time of the case development to provide an investment recommendation.

The market equity beta for Starbucks at the end of 2008 is 0.58. Assume that the risk- free interest rate is 4.0 percent and the market risk premium is 6.0 percent. Starbucks has 735.5 million shares outstanding at the end of 2008. At the start of Year +1, Starbucks' share price was $14.17.

Required:

Part I-Computing Starbucks' Share Value Using Free Cash Flows to Common Equity Shareholders

a. Use the CAPM to compute the required rate of return on common equity capital for Starbucks.

b. Using your projected financial statements from Integrative Case 10.1 for Starbucks, begin with projected net cash flows from operations and derive the projected free cash flows for common equity shareholders for Starbucks for Years +1 through +5. You must determine whether your projected changes in cash are necessary for oper- ating liquidity purposes.

c. Project the continuing free cash flow for common equity shareholders in Year +6. Assume that the steady-state long-run growth rate will be 3 percent in Year +6 and beyond. Project that the Year +5 income statement and balance sheet amounts will grow by 3 percent in Year +6; then derive the projected statement of cash flows for Year +6. Derive the projected free cash flow for common equity shareholders in Year +6 from the projected statement of cash flows for Year +6.

d. Using the required rate of return on common equity from Part a as a discount rate, compute the sum of the present value of free cash flows for common equity share- holders for Starbucks for Years +1 through +5.

e. Using the required rate of return on common equity from Part a as a discount rate and the long-run growth rate from Part c, compute the continuing value of Starbucks as of the start of Year +6 based on Starbucks' continuing free cash flows for common equity shareholders in Year +6 and beyond. After computing continuing value as of the start of Year +6, discount it to present value at the start of Year +1.

f. Compute the value of a share of Starbucks common stock.

(1) Compute the total sum of the present value of free cash flows for equity shareholders (from Parts d and e).

(2) Adjust the total sum of the present value using the midyear discounting adjust- ment factor. (3) Compute the per-share value estimate.

Note: If you worked Integrative Case 11.1 from Chapter 11 and computed Starbucks' share value using the dividends valuation approach, compare your value estimate from that case with the value estimate you obtain here. They should be the same.

Part II-Computing Starbucks' Share Value Using Free Cash Flows to All Debt and Equity Stakeholders

g. At the end of 2008, Starbucks had $1,263 million in outstanding interest-bearing short-term and long-term debt on the balance sheet and no preferred stock. Assume that the balance sheet value of Starbucks' debt equals the market value of the debt. Starbucks faces an interest rate of roughly 6.25 percent on its outstanding debt. Assume that Starbucks will continue to face the same interest rate on this outstand- ing debt capital over the remaining life of the debt. Using the amounts on Starbucks' 2008 income statement in Exhibit 1.27 for Integrative Case 1.1 in Chapter 1, com- pute Starbucks' average tax rate in 2008. Assume that Starbucks will continue to face the same income tax rate over the forecast horizon. Compute the weighted average cost of capital for Starbucks as of the start of Year +1. Compare your computation of Starbucks' weighted average cost of capital with your estimate of Starbucks' required return on equity from Part a. Why do the two amounts differ?

h. Based on your projections of Starbucks' financial statements, begin with projected net cash flows from operations and derive the projected free cash flows for all debt and equity stakeholders for Years +1 through +5. Compare your forecasts of Starbucks' free cash flows for all debt and equity stakeholders Years +1 through +5 with your forecast of Starbucks' free cash flows for equity shareholders in Part b. Why are the amounts not identical-what causes the difference each year?

i. Project the continuing free cash flows for all debt and equity stakeholders in Year +6. Use the projected financial statements for Year +6 from Part c to derive the pro- jected free cash flow for all debt and equity stakeholders in Year +6.

j. Using the weighted average cost of capital from Part g as a discount rate, compute the sum of the present value of free cash flows for all debt and equity stakeholders for Starbucks for Years +1 through +5.

k. Using the weighted average cost of capital from Part g as a discount rate and the long-run growth rate from Part c, compute the continuing value of Starbucks as of the start of Year +6 based on Starbucks' continuing free cash flows for all debt and equity stakeholders in Year +6 and beyond. After computing continuing value as of the start of Year +6, discount it to present value at the start of Year +1.

l. Compute the value of a share of Starbucks common stock. (1) Compute the value of Starbucks' net operating assets using the total sum of the present value of free cash flows for all debt and equity stakeholders (from Parts j and k). (2) Subtract the value of outstanding debt to obtain the value of equity. (3) Adjust the present value of equity using the midyear discounting adjustment factor. (4) Compute the per-share value estimate.

m. Compare your share value estimate from Part f with your share value estimate from Part l. These values should be similar.

Part III-Sensitivity Analysis and Recommendation

n. Using the free cash flows to common equity shareholders, recompute the value of Starbucks shares under two alternative scenarios. Scenario 1: Assume that Starbucks' long-run growth will be 2 percent, not 3 percent as before, and assume that Starbucks' required rate of return on equity is 1 percentage point higher than the rate you computed using the CAPM in Part a. Scenario 2: Assume that Starbucks' long-run growth will be 4 percent, not 3 percent as before, and assume that Starbucks' required rate of return on equity is 1 percentage point lower than the rate you computed using the CAPM in Part a. To quantify the sensitivity of your share value estimate for Starbucks to these variations in growth and discount rates, com- pare (in percentage terms) your value estimates under these two scenarios with your value estimate from Part f.

o. At the end of 2008, what reasonable range of share values would you have expected for Starbucks common stock? At that time, where was the market price for Starbucks shares relative to this range? What would you have recommended?

p. If you computed Starbucks' common equity share value using the dividends-valua- tion approach in Integrative Case 11.1, compare the value estimate you obtained in that case with the estimate you obtained in this case. They should be identical.

Text Book: Financial Reporting, Financial Statement Analysis and Valuation: A Strategic Perspective By James Wahlen, Stephen Baginski, Mark Bradshaw.

Reference no: EM13902263

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