Case study sesson 11+12

SESSION 11&12: VALUATION: MARKET-BASED APPROACHES Case Study: Valuation of Starbucks’ Common Equity Using Market Multiples... REQUIRED: Using your result of projected financial statement

SESSION 11&12: VALUATION: MARKET-BASED APPROACHES Case Study: Valuation of Starbucks’ Common Equity Using Market Multiples

*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’ Value-to-Book Ratio Using the Value-to-Book Valuation Approach

a Using the projected financial statements above for Starbucks, derive the projected residual ROCE (return on common equity) for Starbucks for Years þ1 through þ5 (Calculation – Home preparation)

b 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 ROCE for Year þ6 (Calculation – Home preparation)

c 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 þ1 through þ5 (Calculation – Home preparation)

d Using the required rate of return on common equity from session5&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 ROCE 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 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? (Calculation – Home preparation)

h Use the value-to-book ratio to project Starbucks’ share value (Calculation – Home

preparation)

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

approach in session 5&6, and/or the free cash flows to common equity valuation approach in session 7&8, and/or the residual income valuation approach in session 9&10, 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 (In-class discussion – Group presentation &

Defense)

Part II—Analyzing Starbucks’ Share Price Using the Value-Earnings Ratio, the Price-Earnings Ratio, Price Differentials, and Reverse Engineering

j Use your forecast data for Year þ1 to project Year þ1 earnings per share To do so, divide your projection of Starbucks’ comprehensive income available for common shareholders in Year þ1

by the number of common shares outstanding at the end of 2012 Using this Year þ1 earnings-per-share forecast and using the share value computed in Requirement h, compute Starbucks’ value-earnings ratio (In-class discussion – Group presentation & Defense)

k Using the Year þ1 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-to-book ratios with market-to-book ratios in Requirement g? (In-class discussion – Group presentation & Defense)