Case study sesson 7+8

REQUIRED: Using your result of projected financial statements of Starbucks for Years þ1 through þ5 and the required rate of return on common equity using CAPM estimated in Session5&6, an

SESSION 7&8: VALUATION: CASH-FLOW-BASED APPROACH Case Study: Free Cash Flows Valuation of Starbucks’ Common Equity

*Extra information: 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

REQUIRED: Using your result of projected financial statements of Starbucks for Years þ1

through þ5 and the required rate of return on common equity using CAPM estimated in

Session5&6, answer the following questions:

Part I—Computing Starbucks’ Share Value Using Free Cash Flows to Common Equity Shareholders

a Using your projected financial statements, begin with projected net cash flows from operations and derive the projected free cash flows for common equity shareholders for Starbucks for Years þ1 through þ5 You must determine whether your projected changes in cash are necessary for operating liquidity purposes (Calculation – Home preparation)

b Project the continuing free cash flow for common equity shareholders in Year þ6 Assume that the steady-state, long-run growth rate will be 3% in Year þ6 and beyond Project that the Year þ5 income statement and balance sheet amounts will grow by 3% in Year þ6; then derive the

projected statement of cash flows for Year þ6 Derive the projected free cash flow for common equity shareholders in Year þ6 from the projected statement of cash flows for Year þ6

(Calculation – Home preparation)

c Using the required rate of return on common equity from session 5&6 as a discount rate, compute the sum of the present value of free cash flows for common equity share holders for Starbucks for Years þ1 through þ5 (Calculation – Home preparation)

d 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 þ6 based on Starbucks’ continuing free cash flows for common equity

shareholders in Year þ6 and beyond After computing continuing value as of the start of Year þ6, discount it to present value at the start of Year þ1

e Compute the value of a share of Starbucks common stock (Calculation – Home preparation) (1) Compute the total sum of the present value of free cash flows for equity shareholders (from Requirements c and d)

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

Note: If you computed Starbucks’ share value using the dividends valuation approach in session 5&6, 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 2012, 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% 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 Assume that Starbucks will continue to face a 33% income tax rate over the forecast horizon Compute the weighted-average cost of capital for Starbucks as of the start of Year þ1 Compare your

computation of Starbucks’ weighted-average cost of capital with your estimate of Starbucks’

required return on equity from Requirement a Why do the two amounts differ? (In-class

discussion – Group presentation & Defense)

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 þ1 through þ5 Compare your forecasts of Starbucks’ free cash flows for all debt and equity stakeholders Years þ1 through þ5 with your forecast of Starbucks’ free cash flows for equity shareholders in Requirement b Why are the amounts not identical—what causes the difference each year? (In-class discussion – Group presentation & Defense)

i Project the continuing free cash flows for all debt and equity stakeholders in Year þ6 Use the projected financial statements for Year þ6 from Requirement c to derive the projected free cash flows for all debt and equity stakeholders in Year þ6 (Calculation – Home preparation)

j Using the weighted-average cost of capital from Requirement 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 þ1 through þ5 (Calculation – Home preparation)

k Using the weighted-average cost of capital from Requirement g 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 þ6 based on Starbucks’ continuing free cash flows for all debt and equity

stakeholders in Year þ6 and beyond After computing continuing value as of the start of Year þ6, discount it to present value at the start of Year þ1 (Calculation – Home preparation)

l Compute the value of a share of Starbucks common stock (Calculation – Home preparation) (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

Requirements 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 Requirement e with your share value estimate from Requirement l These values should be similar (In-class discussion – Group presentation & Defense)