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

Question:

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 equity) for Starbucks for Years +1through +5.

c. Assume that the steady-state, long-run growth rate will be 3% in Year +6 and beyond. Project that the Year þ5 income statement and balance sheet amounts will grow by 3% in Year +6; then derive the projected residual ROCE for Year +6.

d. Using the required rate of return on common equity from Requirement 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 Requirement a as a discount rate and the long-run growth rate from Requirement 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 þ6, discount it to present value at the start of Year +1.

f. Compute Starbucks' value-to-book ratio as of the end of 2012 with the following three steps: (1) Compute the total sum of the present value of all future residual ROCE (from Requirements d and e).

(2) To the total from Requirement f (1), add 1 (representing the book value of equity as of the beginning of the valuation as of the end of 2012).

(3) Adjust the total sum from Requirement f (2) using the midyear discounting adjustment factor.

g. Compute Starbucks' market-to-book ratio as of the end of 2012. Compare the value-to-book ratio to the market-to-book ratio. What does the comparison suggest regarding the pricing of Starbucks' shares in the market: underpriced, overpriced, or fairly priced? What investment decision does the comparison suggest?

h. Use the value-to-book ratio to project Starbucks' share value.

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.

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 2012. Using this Year +1 earnings-per-share forecast and using the share value computed in Requirement h, compute Starbucks' value-earnings ratio.

k. Using the Year +1 earnings-per-share forecast from Requirement j and using the share price at the end of 2012, 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 Requirement g?

l. NFor this part only, assume Starbucks's long-run growth beginning in Year +6 will be 1% rather than 3%. With a 1% growth rate, Year +6 comprehensive income will be $2,900 million. Compute Starbucks' price differential at the end of 2012. Compute Starbucks's price differential as a percentage of 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 2012 to solve for the implied expected rate of return. First, assume that value equals price and that your earnings and 3% long-run growth forecasts through Year +6 and beyond are reliable proxies for the market's expectations for Starbucks. Then solve for the implied expected rate

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 2012. The market equity beta for Starbucks at the end of 2012 is 0.75. Assume that the risk-free interest rate is 3.0% and the market risk premium is 6.0%. Starbucks has 749.3 million shares outstanding at the end of 2012, and the share price was $50.15.

n.     Reverse engineer Starbucks’ share price at the end of 2012 to solve for the implied expected long-run growth. First, assume that value equals price and that your earnings forecasts through Year þ5 are reliable proxies for the market’s expectations for Starbucks. Also assume that the discount rate implied by the CAPM (computed in Requirement 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. 

Financial Statements
Financial statements are the standardized formats to present the financial information related to a business or an organization for its users. Financial statements contain the historical information as well as current period’s financial...
Balance Sheet
Balance sheet is a statement of the financial position of a business that list all the assets, liabilities, and owner’s equity and shareholder’s equity at a particular point of time. A balance sheet is also called as a “statement of financial...
Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal...
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