Case study sesson 9+10

SESSION 9&10: VALUATION: EARNINGS-BASED APPROACH Case Study: Residual Income Valuation of Starbucks’ Common Equity... REQUIRED: Using your result of projected financial statements of Sta

SESSION 9&10: VALUATION: EARNINGS-BASED APPROACH Case Study: Residual Income 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 the Residual Income Valuation

Approach

a Using your projected financial statements from Integrative Case 10.1 for Starbucks, derive the projected residual income for Starbucks for Years þ1 through þ5 (Calculation – Home

preparation)

b Project the continuing residual income 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 residual income for Year þ6 (Calculation – Home preparation)

c Using the required rate of return on common equity from session5&6 as a discount rate, compute the sum of the present value of residual income for Starbucks for Years þ1 through þ5 (Calculation – Home preparation)

d Using the required rate of return on common equity from session 5&6 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 residual income 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)

e Compute the value of a share of Starbucks common stock (Calculation – Home preparation) (1) Compute the total sum of the present value of all future residual income (from Requirements

c and d)

(2) Add the book value of equity as of the beginning of the valuation (that is, as of the end of

2012, or the start of Year þ1)

(3) Adjust the total sum of the present value of residual income plus book value of common equity using the midyear discounting adjustment factor

(4) Compute the per-share value estimate

Part II—Sensitivity Analysis and Recommendation

g Using the residual income valuation approach, re-compute the value of Starbucks shares under two alternative scenarios (Calculation – Home preparation)

Scenario 1: Assume that Starbucks’ long-run growth will be 2%, not 3% as above, and that Starbucks’ required rate of return on equity is 1 percentage point higher than the rate you

computed using the CAPM in session 5&6

Scenario 2: Assume that Starbucks’ long-run growth will be 4%, not 3% as above, and that Starbucks’ required rate of return on equity is 1 percentage point lower than the rate you

computed using the CAPM session 5&6 To quantify the sensitivity of your share value estimate

for Starbucks to these variations in growth and discount rates, compare (in percentage terms) your value estimates under these two scenarios with your value estimate from Requirement e

h At the end of 2012, what reasonable range of share values would you have expected for Starbucks common stock? At that time, where was the market price for Starbucks shares relative

to this range? What would you have recommended? (In-class discussion – Group presentation & Defense)

i If you computed Starbucks’ common equity share value using the dividends valuation

approach in session5&6, compare the value estimate you obtained in that case with the estimate

you obtained in this case

Similarly, if you computed Starbucks’ common equity share value using the free cash flows to

common equity shareholder valuation approach in session7&8, compare the value estimate you

obtained in that case with the estimate you obtained in this case

(In-class discussion – Group presentation & Defense)