Solved: Integrative Case 10 1 projected financial

statements for Starbuc

Integrative Case 10.1 projected financial statements for Starbucks for Years +1 through +5. This
portion of the Starbucks Integrative Case applies the techniques in Chapter 11 to compute
Starbucks’ required rate of return on equity and share value based on the dividends valuation
model. This case also compares the 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 was 0.58. Assume that the riskfree
interest rate was 4.0 percent and the market risk premium was 6.0 percent. Starbucks had
735.5 million shares outstanding at the end of 2008, and share price was $14.17.

Required
a. Use the CAPM to compute the required rate of return on equity capital for Starbucks.
b. Compute the weighted average cost of capital for Starbucks as of the start of Year +1. At the
start of Year +1, Starbucks had $1,263 million in outstanding interest bearing debt on the
balance sheet and no preferred stock. Assume that the balance sheet value of Starbucks’ debt
is approximately equal to the market value of the debt.
Assume that at the start of Year +1, Starbucks will incur interest expense of 6.25 percent on
debt capital and that Starbucks’ average tax rate is 36.0 percent.
c. From your forecasts of Starbucks’ financial statements for Years +1 through +5, derive the
projected dividends using the projected amounts for the plug to dividends less the net amounts
of common stock issued each year (if any). Then compute projected dividends for Starbucks for
Years +1 through +5 using the clean surplus accounting approach based on projected amounts
for comprehensive income and common shareholders’ equity. The projected amounts of
dividends under the two approaches should be identical.
d. Use the clean surplus accounting approach to project the continuing dividend in Year +6.
Assume that the steady-state long-run growth rate will be 3 percent in Year +6 and beyond.
e. Using the required rate of return on common equity capital from Part a as a discount rate,
compute the sum of the present value of dividends for Starbucks for Years +1 through +5.
f. Using the required rate of return on common equity capital from Part a as a discount rate and
a 3.0 percent long-run growth rate, compute the continuing value of Starbucks as of the
beginning of Year +6 based on Starbucks’ continuing dividends in Year +6 and beyond. After
computing continuing value, bring continuing value back to present value at the start of Year +1.
g. Compute the value of a share of Starbucks’ common stock.
(i) Compute the sum of the present value of dividends including the present value of continuing
value.
(ii) Adjust the sum of the present value using the midyear discounting adjustment factor.
(iii) Compute the per-share value estimate.
h. Using the same set of forecast assumptions as before, 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,

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 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 estimate of
share value for Starbucks to variations in long-run growth and discount rates, compare (in
percentage terms) your value estimates under these two scenarios with your value estimate
from Part f.
i. What reasonable range of share values would you expect for Starbucks’ common stock?
Where is the current price for Starbucks’ shares relative to this range? What do you
recommend?

Integrative Case 10 1 projected financial statements for Starbuc

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