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 financial statements from Integrative Case 10.1 and apply the techniques in Chapter 14 to compute Starbucks’ required rate of return on equity and share value based on the value-to-book valuation model. We also compare our value-to-book ratio estimate to Starbucks’ market-to-book ratio at the time of the case to determine an investment recommendation.
In addition, we compute the value-earnings and price-earnings ratios and the price differential and we reverse-engineer Starbucks’ share price as of the end of 2008. The market equity beta for Starbucks at the end of 2008 is 0.58. Assume that the riskfree 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’ Value-to-Book Ratio Using the Value-to-Book Valuation
Approach
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, derive the projected residual ROCE (return on common shareholders’ equity) for Starbucks for Years +1 through +5.
c. 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 residual ROCE 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 residual ROCE 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 residual ROCE 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 Starbucks’ value-to-book ratio as of the end of 2008 with the following three steps: (1) Compute the total sum of the present value of all future residual ROCE (from Parts d and e).
(2) To the total from (1), add 1 (representing the book value of equity as of the beginning of the valuation as of the end of 2008).
(3) Adjust the total sum from (2) using the midyear discounting adjustment factor.
g. Compute Starbucks’ market-to-book ratio as of the end of 2008. Compare the value-to- book ratio to the market-to-book ratio. What investment decision does the comparison suggest? What does the comparison suggest regarding the pricing of Starbucks’ shares in the market: underpriced, overpriced, or fairly priced?
h. Use the value-to-book ratio to project the value of a share of common equity in Starbucks.
i. If you computed Starbucks’ common equity share value using the dividends valuation approach in Integrative Case 11.1 in Chapter 11, and/or the free cash flows to common equity valuation approach in Integrative Case 12.1 in Chapter 12, and/or the residual income valuation approach in Integrative Case 13.1 in Chapter 13, compare the value estimate you obtained in those cases with the estimate you obtained in this case. You should obtain the same value estimates under all four approaches.
If you have not yet worked those prior cases, you would benefit from doing so now.

Part II—Analyzing Starbucks’ Share Price Using the Value-Earnings Ratio, the Price-
Earnings Ratio, Price Differentials, and Reverse Engineering
j. Use your forecast data for Year +1 to project Year +1 earnings per share. To do so, divide your projection of Starbucks’ comprehensive income available for common shareholders in Year +1 by the number of common shares outstanding at the end of 2008. Using this Year +1 earnings-per-share forecast and using the share value computed in Part h, compute Starbucks’ value-earnings ratio.
k. Using the Year +1 earnings–per-share forecast from Part j and using the share price at the end of 2008, compute Starbucks’ price-earnings ratio. Compare Starbucks’ value-earnings ratio with its price-earnings ratio. What investment decision does the comparison suggest? What does the comparison suggest regarding the pricing of Starbucks’ shares in the market: underpriced, overpriced, or fairly priced? Does this comparison lead to the same conclusions you reached when comparing value-tobook ratios with market-to-book ratios in Part g?
l. Compute Starbucks’ price differential at the end of 2008. Compute Starbucks’ price differential as a percentage of Starbucks’ risk-neutral value. What dollar amount and what percentage amount has the market discounted Starbucks’ shares for risk?
m. Reverse-engineer Starbucks’ share price at the end of 2008 to solve for the implied expected rate of return. First, assume that value equals price and that your earnings and growth forecasts through Year +6 and beyond are reliable proxies for the market’s expectations for Starbucks. Then solve for the implied expected rate of return (the discount rate) the market has impounded in Starbucks’ share price.
n. Reverse-engineer Starbucks’ share price at the end of 2008 to solve for the implied expected long-run growth. First, assume that value equals price and that your earnings forecasts through Year +5 are reliable proxies for the market’s expectations for Starbucks. Also assume that the discount rate implied by the CAPM (computed in Part a) is a reliable proxy for the market’s expected rate of return. Then solve for the implied expected long-run growth rate the market has impounded in Starbucks’ share price.