In Integrative Case 10.1, we projected financial statements for Starbucks for Years +1 through +5. In this portion of the Starbucks Integrative Case, we use the projected financial statements from Integrative Case 10.1 and apply the techniques in Chapter 13 to compute Starbucks’ required rate of return on equity and share value based on the residual income valuation model. We also compare our value estimate to Starbucks’ share price at the time of the case to provide an investment recommendation.

The market equity beta for Starbucks at the end of 2008 is 0.58. Assume that the riskfree interest rate is 4.0 percent and the market risk premium is 6.0 percent. Starbucks has 735.5 million shares outstanding at the end of 2008. At the start of Year +1, Starbucks’ share price was $14.17.

Required

Part II—Sensitivity Analysis and Recommendation

a. Using the residual income valuation approach, 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 above, and 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 above, and 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 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 Part f.

b. At the end of 2008, 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?

c. If you computed Starbucks’ common equity share value using the dividends valuation approach in Integrative Case 11.1 in Chapter 11, 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 shareholders valuation approach in Integrative Case 12.1 in Chapter 12, compare the value estimate you obtained in that case with the estimate you obtained in this case. You should obtain the same value estimates under all three approaches. If you have not worked both of those cases, you would benefit from doing so now.