Question 1 Overall, Starbucks’ performance has been mixed over the past six months. On April 13, 2012, its stock price reached a high of $61.67 per share and closed at $57.37 per share. Since April, the price of Starbucks’ stock fell on average in the following closing months of May and June before reaching a low of $43.16 in the opening days of August. The fall was correlated with the release of Starbucks’ third quarter annual report, which showed a less-than-expected performance for that quarter; the earnings per share were $0.43 compared to a market expectation of $0.45 (Baertlein). Since then, the price of Starbucks’ stock has gradually increased. Although market risk factors like decreased consumer spending may have impacted
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Clearly, there were significant changes to Starbucks’ capital structure, so the Free Cash Flow To Equity (FCFE) approaches are not because the returns on equity are more sensitive to changes in financial leverage than WACC (the weighted average cost of capital). Furthermore, Starbucks’ has been a consistent leader in the foodservices/special eateries industry; valuing Starbucks under the exponential model may overstate or understate its value. Therefore, the FCFF approach based on linear decline, although conservative, best describes the value of Starbucks. The intrinsic value of Starbucks under this method is $55.59, but Starbucks, as of September 21, 2012, has been trading at $51.07. Therefore, Starbucks is undervalued, and investors should buy its shares.
Question 5 The estimated invested capital does not affect the valuation of the firm in the discounted EVA valuation model. Under the EVA valuation model, the total enterprise value of a firm is separated into invested capital plus the present value of forecasted future economic profits. It is illustrated as follows:
Invested capital, IC0, increases the overall value of the firm, but a subsequent decrease in total economic value offsets the effects of invested capital. In the numerator of the equation, economic profit is NOPAT minus the capital charge (WACC x ICt-1). Invested capital is included in the capital charge, so as invested capital increases, the capital charge increases, and