Miranda Harrimon

Starbucks 11.1

a. Following the CAPM, Starbucks faces a required rate of return on equity capital of 7.5% at the
end of 2012. This rate is computed as follows:

E[RSBUX] = E[RF] + SBUX E[RM RF] = 0.03 + [0.75 0.06] = 0.0750

b. You can use the Starbucks case to demonstrate computing weighted-average cost of capital.
Starbucks capital structure at the end of 2012 consists of the following amounts and
proportions:

Amount Weight

Debt $550 million 0.014

Common Equity $37,577 million = $50.15 per share 749.3 million shares 0.986

Total $38,127 million 1.0000

The equation presented in this Chapter for computing weighted-average cost of capital is as
follows.

RA = [wD RD (1 Income Tax Rate)] + [wP RP] + [wE RE] + [wNCI RNCI]

Starbucks faces a 6.25% interest rate on this debt and a 33.0% tax rate. Using this equation,
Starbucks weighted-average cost of capital at the end of 2012 is computed as follows:

RA = [0.014 0.0625 (1 0.33)] + [.986 0.0750]

= 0.0006 + 0.0739 = 0.0745, or 7.45%.

c. The projected amounts of dividends for Starbucks for Years +1 through +5 are straightforward
to derive using the projected dividends, the plug to treasury stock purchases, and the changes in
common shareholders equity. Dividends can be determined as follows (in millions):

Year +1 Year +2 Year +3 Year +4

Year +5

Projected Dividends $ 582 $664 $ 754 $ 852

$1,062

Plug to Treasury Share Purch. $ 605 226 576 494 42

+ Beginning Paid-in Capital $ 40 44 50 55 61

Ending Paid-in Capital 44 50 55 61

70

= Dividends $1,183 $884 $1,325 $1,340

$1,096
 The projected value-relevant dividends for Starbucks for Years +1 through +5 are also
straightforward to derive using the clean surplus accounting approach and the projected
comprehensive income and equity amounts. The only items affecting common shareholders
equity are comprehensive income (which equals net income), plus small amounts of common
equity issues each year to keep paid-in capital equal to 0.5% of assets, minus dividends and
share repurchases. Therefore, dividends can be determined using clean surplus, as follows:

Dt = CIt + BVt-1 BVt

Year +1 Year +2 Year +3 Year +4

Year +5

Comprehensive Income $1,573 $1,793 $2,038

$2,303 $2,871

+ Beginning Book Value of Equity 5,109 5,499 6,409 7,123 8,086

Ending Book Value of Equity 5,499 6,409 7,123

8,086 9,862

= Dividends $1,183 $ 884 $ 1,325 $

1,340 $ 1,096

d. Using the approach shown in the chapter to project the continuing dividend in Year +6
assuming a steady-state long-run growth rate of 3% results in the following dividend amount (in
millions) in Year +6. D T+1 = [CIT (1 + g)] + BVT [BVT (1 + g)]

= [$2,871 1.03] + $9,862 [$9,862 1.03]

= $2,958 + $9,862 $10,157 = $2,662

e. The data in Exhibit 11.C show that the sum of the present value of dividends for Starbucks for
Years +1 through +5, discounted at 7.5%, is $4,697.8 million.

f. The data in Exhibit 11.C show that the present value at the start of Year +1 of the continuing
dividends in Years +6 and beyond amounts to $41,201.0 million.

g. The data in Exhibit 11.C show the following computations:

(1) The sum of the present value of dividends is $45,898.9 million ($4,697.8 million + $41,201.0
million).

(2) After adjusting the sum of the present value using the mid-year discounting adjustment
factor of 1.0375 (1 + 0.075/2), the total present value of dividends is $47,620.1 million.

(3) After dividing the total present value by 749.3 million shares outstanding, the per share
value estimate for Starbucks equals $63.55.

h. The data in Exhibit 11.D show the results of various sensitivity analysis scenarios, varying
discount rates and growth rates.
Scenario 1: Assuming 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 computed
using the CAPM in Requirement a (that is, 8.5%), the resulting share value estimate falls to
$45.25 per share.

Scenario 2: Assuming 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 computed
using the CAPM in Requirement a (that is, 6.50%), the resulting share value estimate increases
dramatically to $91.66 per share.

i. At the start of Year +1, Starbucks share price was $50.15. The baseline share value estimate is
$63.55, implying that Starbucks shares are underpriced by roughly 27%. Sensitivity analysis
reveals that slight variations in the long term growth rate and discount rate can cause the share
value estimate to vary between $45 per share (10% below the current price) up to over $90 per
share (80% above the current price). If the forecast and valuation assumptions are reasonable,
the current share price falls in the lower end of the value estimate range. Students would
conclude that Starbucks shares are slightly under priced at roughly $50 per share and, therefore,
would recommend a buy (not a strong buy).

Exhibit 11.C
Dividends Valuation for Starbucks
(Intgrative Case 11.1)

Continui
ng
1 2 3 4 5 Value
Year Year Year Year Year
Dividends-Based Valuation +1 +2 +3 +4 +5 Year +6
Dividends Paid to Common 1062.
Shareholders 582.2 663.5 754.2 852 4
Less: Common Stock Issues -4.1 -5.5 -5.8 -6 -8.6
Plus: Common Stock Repurchases 605.3 225.6 576 493.5 41.9
1138. 1324. 1339. 1095.
Dividends to Common Equity 4 883.6 3 6 8 2661.7

Present Value Factors 0.93 0.865 0.805 0.749 0.697

1100. 1003.
Present Value Net Dividends 8 764.6 1066 1 763.3
Sum of Present Value Net 4697.
Dividends 8
Present Value of Continuing Value 41201
45898
Total .9
1.037
Adjust to Midyear Discounting 5
47620
Total Present Value Dividends .1
Shares Outstanding 749.3
$63.5
Estimated Value per Share 5

Current Share Price $50.1

 5

Percent Difference 27%

Exhibit 11.D
Sensitivity Analysis of Dividends Valuation for
Starbucks
Integrative Case
11.1

Long-Run Growth Assumptions

63.55 0% 2% 3% 4% 5% 6% 8%
104.4 149.5 284.6
Discounts Rates 5% 68.44 8 3 8
139.8
6% 55.89 76.88 97.87 4 265.78
110.9 499.8
6.5% 51.08 67.7 83.14 2 175.75 7
164.1
7.5% 43.43 54.41 63.55 77.93 103.8 7
434.2
8.5% 37.62 45.25 51.14 59.66 73.03 97.11 5
215.8
9% 35.21 41.67 46.5 53.28 63.44 80.38 8
106.7
10% 31.15 35.87 39.25 43.75 50.05 59.5 5
11% 27.84 31.39 33.83 36.97 41.15 47.01 70.43
12% 25.12 27.84 29.65 31.91 34.83 38.71 52.31
13% 22.83 24.95 26.32 28.01 30.11 32.81 41.46
14% 20.89 22.56 23.62 24.9 26.46 28.41 34.26
15% 19.22 20.55 21.39 22.37 23.55 25 29.13
18% 15.4 16.11 16.54 17.03 17.59 18.25 19.96
20% 13.54 14.02 14.31 14.63 14.99 15.4 16.44