In Integrative Case 10.1, we projected financial statements for Starbucks for Years +1 through +5. In this

Question:

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 12 to compute 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 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

Computing Starbucks’ Share Value Using Free Cash Flows to All Debt and Equity Stakeholders

a. 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 outstanding 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, compute 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?

b. 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?

c. 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 projected free cash flow for all debt and equity Stakeholders in Year +6.

d. 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.

e. 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.

f. 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.

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

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... Stakeholders
A person, group or organization that has interest or concern in an organization. Stakeholders can affect or be affected by the organization's actions, objectives and policies. Some examples of key stakeholders are creditors, directors, employees,... 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... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... 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... Free Cash Flow
Free cash flow (FCF) represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. Unlike earnings or net income, free cash flow is a measure of profitability that excludes the...