Introduction to Corporate Finance

PARt 2: VALUAtIoN, RISk ANd REtURN

equals the total value of the company’s shares. Simply divide this total by the number of shares outstanding

to calculate the value per share, P 0.

example

Had a good cup of coffee lately? Probably the best-known purveyor of coffee in the world is Starbucks

Corporation. By 2015, the company had nearly 22,000 coffeehouses in 50 countries, and its coffee shops

had become so ubiquitous that investors wondered what prospects the company had for additional growth.

As a signal of a potential slowdown in growth, Starbucks closed a number of its outlets in some countries,

including Australia, because of fierce local competition. Starbucks was listed on the New York Stock

Exchange, and its shares traded around $US40 late in 2013. At that time, Starbucks had debt with a market

value of about $US1.3 billion, no preferred shares and 1.5 billion shares of ordinary shares outstanding. Its

end-of-2013 free cash flow (FCF), calculated using the techniques presented in Chapter 2, was about $1.76

billion. After posting annual revenue growth rates exceeding 20% in every year from 2003 to 2007, Starbucks

was showing signs of slowing down, with revenue growth between 2007 and 2014 averaging just 4.0% per

year. In fact, the company was shifting its strategy away from its traditional coffeehouse business toward a

consumer products focus. Given the maturation of Starbucks’ traditional business, and the uncertainty of its

success in changing into a purveyor of coffee-related consumer products, we will assume an optimistic long-

run growth rate of 4.5% for the company’s free cash flows. We also calculate that Starbucks’ WACC equals

7.6% at the end of 2013.

To estimate the value of Starbucks ordinary shares, we begin by using the constant growth model to

value the entire enterprise. Our forecast for 2014 free cash flow is just 4.5% more than the figure generated

in 2013:

FCF(2014) = FCF(2013) × 1.045 = $US1.76 × 1.045

= $US1.84 billion

To calculate the present value of Starbucks’ future free cash flows, we simply apply Equation 5.4:

Vcompany =

−

=

$1.84

(0.760.045)

$59.33billion

Substituting Starbucks’ enterprise value – Vcompany – of $US59.33 billion, its debt value – Vdebt – of $US1.3

billion, and its preferred share value – Vpreferred – of $US0 into Equation 5.7, we get its total ordinary shares share

value, Vshare:

Vshare = $US59.33 – $US1.3 – $US0

= $US58.03 billion

Dividing the total share value by the 1.5 billion shares outstanding at the end of 2013, we get the per-share

value of one of Starbucks’ shares, P 2013.

P ==

$58,030,000,000

1, 500,000,000

2013 $38.68

Our estimate of Starbucks’ total ordinary shares value in late 2013 of $US58,030,000,000, or $US38.68 per

share, is slightly below its actual $US40 during that time.^10

The free cash flow approach offers an alternative to the dividend discount model that is especially

useful when valuing shares that pay no dividends. As we will see in the next section, security analysts

10 Here’s an interesting postscript for this example. At the time of that analysis, in early 2011, the ‘Summary’ screen for Starbucks at the Yahoo

Finance site (www.finance.yahoo.com) showed a US dollar market capitalisation of $24 billion (versus our estimate of about $25.45 billion)

and a one-year price estimate for the share of $35.47 per share (versus our estimate of about $34.25 per share). It appears that our estimates

are in the ballpark.