Pro$-$forma financial statements for Starbucks, Inc. for $20112020$ are available on Blackboard. Using the pro$-$forma financial statements for fiscal years $20112020$ as well as the assumptions provided below, estimate the value of equity per share for Starbucks, Inc. as of $10/1/2010($beginning of the $2011$ fiscal year$)$ using the discounted cash flows $($DCF$),$ weighted$-$average cost of capital $($WACC$)$ method.

Additional Assumptions

$1.$ Starbucks long$-$term targeted capital structure $($to be used for the calculation of WACC$)$ is calculated using $0\%$ debt and $100\%$ common stock. Assume the cost of debt $($pretax$)$ is the assumed interest rate on debt of $6\mathrm{.}25\%.$ Also assume that Starbucks$$ beta is $1,$ the risk$-$free rate is $3\%$ and the market risk premium is $6\%.$

$2.$ Starbucks hits a steady state beginning in year $2021.$ See the guidance on the post$-$ forecast horizon growth rates on the following pages.

$3.$ Starbucks$$ marginal tax rate and the tax rate applicable to all operating and financing activities is $35\%$ for all years.

$4.$ Short$-$term and long$-$term investments are considered financial assets. The cash account is considered operating.

$2$

$5.$ Starbucks has $$611\mathrm{.}3$ million worth of employee stock options outstanding as of the end of the fiscal year $2010.($See Footnote $14$ in the $2010$ financial statements to see the source of this amount.$)$

You can use the format of the valuation examples in the lecture notes to structure or format your spreadsheet approach to valuation. The spreadsheet on the course website includes separate tabs for each analysis.

Steps in Implementing the Discounted Cash Flow WACC Method:

$1.$ Estimate free cash flows $($FCF$)$ in each year, $20112020$ using each of the three approaches discussed in class $($in Outline #$7)\mathrm{.}1$

$2.$ Estimate the cost of equity $($Re$)$ using risk$-$free rate, beta, and market risk premium assumptions. Then estimate WACC using Re$,$ Rd$,$ and the targeted capital structure assumptions. $($You may ignore the presence of financial assets in this calculation of WACC.$)$

$3.$ Use WACC to estimate the present value $($as of $10/1/2010)$ of free cash flows for $2011-2020,$ assuming that the projected cash flows occur at the end of each year. $($Assume each year ends on $9/30/$XX$,$ so that no partial year adjustments are needed.$)$

$4.$ Estimate free cash flows $($FCF$)$ for $2021.$

$5.$ Estimate the present value $($as of $10/1/2010)$ of free cash flows beyond year $2020.$ The expected growth rate $($g$)$ of Free Cash Flows is $2\%$ beyond the forecast horizon.

$6.$ Estimate the present value of all future free cash flows $($i$.$e$.,$ sum of $3$ and $5).$

$7.$ Add the fair value of financial $($i$.$e$.,$ non$-$operating$)$ assets as of the end of fiscal year $2010($you may assume that the book value of financial assets on the $2010$ balance sheet ~ fair value for these assets$).$

$8.$ Subtract the fair value of interest$-$bearing debt outstanding as of the end of fiscal year $2010($you may assume that the book value of debt on the $2010$ balance sheet ~ the fair value of debt$).$

$9.$ Subtract the after$-$tax value of the outstanding employee stock options as of the end of fiscal year $2010.($i$.$e$.,$ multiply value by $(1$ tax rate$)).$

$1$ Stock$-$based compensation expense is added back to Net Income to compute cash from operations in the GAAP Statement of Cash Flows because it does not use up cash. However, to calculate free cash flows in a valuation context you should treat it as if it is a $$cash equivalent$$ expense by subtracting the stock$-$based compensation expense from cash flow from operations to correctly account for this cost to shareholders. The net effect of expensing stock options on the income statement, adding it back on the cash flow statement, and subtracting it from cash from operations in the computation of free cash flows $($using method $2)$ is to reduce free cash flows by the after$-$tax compensation expense. This appropriately reflects the after$-$tax cost to shareholders.

$3$

$10.$ Divide by the number of shares of common stock outstanding as of the end of fiscal year $2010$ to determine the estimated value per share. Info on number of shares can be found in the $10-$K on the course website $($included with Starbucks $$ Part I$).$

The actual stock price for Starbucks, Inc. on $10/1/2010$ was $$25\mathrm{.}94.$ How does this compare to your estimate?