FinalReport (2)

Starbucks Valuation Report

Leavey School of Business

of

SANTA CLARA UNIVERSITY

Submitted on: June 6th, 2016

Spring 2016

Prepared by: Azmeena Zaveri

Divya Pari

Poonam Jadhav

Sakshi Gambhir

Tommy Baldacci

Table of Contents 1. Economic Environment ........................................................................................................................... 1 1.1 Global ...................................................................................................................................................................... 1 1.2 US ............................................................................................................................................................................. 1 1.3 EMEA ....................................................................................................................................................................... 1 1.4 CAP ........................................................................................................................................................................... 1

2. Industry Analysis: ..................................................................................................................................... 1 2.1 Fast Food Industry Outlook ............................................................................................................................. 1 2.2 Major Competitors ............................................................................................................................................. 1

3. Company Description .............................................................................................................................. 2

4. Cost of Debt (Kd) ....................................................................................................................................... 2 4.1 Risk Free Rate ...................................................................................................................................................... 2 4.2 Default Premium ................................................................................................................................................. 2 4.3 Interest Coverage Ratio .................................................................................................................................... 3 4.4 Altman Z Score ..................................................................................................................................................... 3 4.5 Starbuck Debt Rating-‐ ....................................................................................................................................... 4 4.6 Starbucks Pretax & Post Tax Cost of Debt across maturities ............................................................... 4

5. Value of Debt-‐ ............................................................................................................................................. 4 5.1 Starbucks Value of Long Term Debt ............................................................................................................. 4 5.2 Starbuck’s Value of Lease-‐ ............................................................................................................................... 5 5.3 Weighted Average Cost of Debt ...................................................................................................................... 5

5.4 Total Value of Debt and Lease Obligations .................................................................................... 6

6. Cost of Equity .............................................................................................................................................. 6 6.1 Beta (β): ................................................................................................................................................................. 6 6.2 Risk free rate (Rf ): ............................................................................................................................................. 7 6.3 Market Risk Premium (Rm -‐ Rf ): ..................................................................................................................... 7

7. Weighted average cost of capital (WACC) ......................................................................................... 8 8 Estimating Starbucks Enterprise and Equity Value ....................................................................... 9 8.1 Valuation ............................................................................................................................................................... 9 8.2 Valuation Techniques ....................................................................................................................................... 9 i. Discounted Cash Flow (DCF) .............................................................................................................................................. 9 ii. Relative Valuation .................................................................................................................................................................. 9

8.3 Starbucks Enterprise Value Calculation using Discounted Cash Flow Model ................................ 9 a.i. Estimating Starbucks Current (Base year) Free Cash Flow (FCF) .............................................................................. 10 Net Operating Profit After Taxes (NOPAT) ............................................................................................................................ 10 Net Capital Expenditure (Net Capex) ....................................................................................................................................... 10 Changes in Net Working Capital ................................................................................................................................................. 11 Starbucks Current (Base Year) Free Cash Flow ................................................................................................................... 11

a.ii. Estimating Starbucks Future Free Cash flows .................................................................................................................... 11 i. Determining an appropriate forecasting period ............................................................................................................. 12 ii. Normalizing NOPAT, Net Capex, and Change in Working Capital to Revenue Ratios ................................... 12 iii. Forecasting Revenue ................................................................................................................................................................ 12

b. Estimating Starbucks Terminal Value using Perpetuity Growth Method .................................................................. 13 i. Estimating Expected future Cashflow as at 2020 ............................................................................................................ 13 ii. Determining Long Term Growth Rate ................................................................................................................................ 14 iii. Determining the Discount Rate to be used ...................................................................................................................... 14

2. Determining Discount Rate ............................................................................................................................................ 14 3. Calculating Present Value of Future Free Cash Flows ........................................................................................ 14 4. Estimating Starbucks Equity Value ............................................................................................................................. 14

9. Relative Valuation: ................................................................................................................................. 15

9.1 Creation of master list of comparables .................................................................................................... 15 9.2 Identification of value drivers ..................................................................................................................... 15 9.3 Creation of the elimination and acceptance matrix ............................................................................. 16 9.4 Estimation of Valuation ratios for valuation matrix ............................................................................ 16 9.4.1 Enterprise Value/EBITDA .................................................................................................................................. 16 9.4.2 Enterprise Value/Revenue ................................................................................................................................ 16

9.5 Adjusting for differences ............................................................................................................................... 17 9.6 Estimation of the enterprise value and equity value of Starbucks ................................................. 17

References ...................................................................................................................................................... 18 Appendix –Exhibits ..................................................................................................................................... 19

12.1 Exhibit-‐ 5A-‐ Interest Coverage Ratio .................................................................................................................. 21 12.2 Exhibit 5B-‐ Altman Z-‐Score ........................................................................................................................ 22

List of Tables

Table no. Description 0.1 Starbuck’s Valuation Summary 2.1 Competitor data for the fiscal year 2014-‐2015 4.1 US Treasury Yields 4.2 Starbucks Interest Coverage Ratio 4.3 Starbucks Altman Z Score-‐ 4.4 Credit Spreads 4.5 Starbucks Pretax & Post Tax Cost of Debt across maturities-‐ 5.1 Starbucks Value of Long Term Debt

5.2 Starbucks Lease Payments

5.3 Weighted Average Cost of Debt 6.1 Starbucks Beta 6.2 Market Risk Premium 7.1 Starbucks Weighted Average Cost of Capital 8.1 Starbucks NOPAT for Year Ended September 2015 8.2 Starbucks Net Capital Expenditures for 2015 8.3 Starbucks Changes in Net Working Capital for the year 2014 – 2015 8.4 Starbucks Free Cash Flow for the Year Ended September 2015 8.5 Starbucks Common Size Ratios 8.6 Starbucks Revenue Forecast Model -‐ 2016 8.7 Starbucks Growth Rates for Forecasted Period 8.8 Starbucks Forecasted FFCF 8.9 Starbucks Terminal Value Calculation 8.10 Starbucks Present Value of FFCF 8.11 Starbucks Equity and Per Share Value as at September 201 9.1 Comparable from Analysts Reports 9.2 Elimination and Acceptance Matrix 9.3 Valuation Matrix 9.4 Enterprise and Equity Value of Starbucks 9.5 Adjustments to Revenue and EBITDA median multiple 9.6 Enterprise and Equity Value of Starbucks based on adjusted median multiples

Executive Summary Starbucks is an American coffee company and coffeehouse chain that offers premium teas, fine pastries, and other

specialty goods. There are more than 24,000 stores open in 70 countries across the world. Starbucks falls under the

category of the fast food industry, a $581 billion global industry that, according to IBISWorld.com, is expected to

grow at 2.6% during 2016. Emerging markets internationally represent a key opportunity for the fast food

restaurant industry, and Starbucks has become increasingly reliant on these markets in recent years for revenue

growth. There are two main methods of valuation used to determine the business value for Starbucks. The first, and primary

one used was the Discounted Cash Flow Method to obtain the Terminal Business Value. The secondary method used

was the Market Approach, also known as Relative Valuation Method, using comparable company valuations as a

reference to deliver a Fair Market Value for Starbucks. The Relative Valuation Approach was used as a secondary

method due to the limited number of companies to compare directly to based on the unique set of offerings

Starbucks has including: coffee, food, tea, and alcoholic beverages, sold at a global scale. Cost of debt was estimated to evaluate the rate at which Starbucks can issue debt today and the rate that is required

to be paid to use debt financing. It was calculated as an addition of risk free rate and default premium. A synthetic

bond rating of A+ was estimated by comparing Starbuck’s Interest Coverage ratio and Altman Z-‐score to the

companies classified as per the S&P bond ratings. We added the credit spread for A+ to the risk free rate for the

appropriate maturity period to estimate the cost of debt for Starbucks across various maturities. To determine the

market value of debt we calculate the present value of the cash flows associated with debt, using the cost of debt as

the discount rate. One of the most significant debt-‐like obligations for Starbucks was lease payments. To estimate

the value of lease, we calculate the present value of the future lease payments, similar to the calculation of value of

long-‐term debt. The total Value of Debt and Lease Obligations is $7291.35 million. A weighted average cost of debt

was then estimated as 2.056%, based on the amount of PV of debt payments including lease payments, forecasted

for the year’s post 2016.

The Cost of Equity is the rate of return required by the company's equity investors to compensate for the risk they

undertake by investing their capital. It was calculated using the CAPM, Capital Asset Pricing Model, which required

estimating the stock’s volatility (beta), risk free rate and market risk premium. The cost of equity was then

calculated as 7.87%. The Weighted Average Cost of Capital (WACC) is the overall required return on the company as a whole. It is

calculated by multiplying cost of equity and after tax cost of debt with their respective proportional weight and then

summed. WACC was calculated as 7.36%. A revenue generator formula was created based on the number of stores predicted to open internationally as well

as the Comparable Store Sales Growth. 2016 revenue projections were calculated to be 12.2% with straight-‐line

depreciation revenue growth across the years 2016-‐2020 until reaching the perpetuity growth rate of 4.14%, the

sum of the forecasted GDP growth rate and inflation rate.

The Enterprise Value of the company using the Discounted Cash Flow Method was determined through projections

of future free cash flows over the next 5 years based on a number of assumptions. The projected future free cash

flows were discounted using the Weighted Average Cost of Capital, calculated to be 7.36%. Starbucks Enterprise

Value is estimated at $99,109.43 million with Equity Value, $93,348 million, which was determined through

subtracting the Interest Bearing Debt and Long Term Liabilities, $7,291 million, and adding the Cash Balance,

$1,530, to the Enterprise Value. The Equity value was then divided by the number of shares outstanding, 1496, in

order to obtain a per share price of $62.40.

Starbucks Equity and Per Share Value as at September 2015 Millions USD Starbucks Enterprise Value 99,109.43 Less: Debt Value 7,291.35 Add: Cash 1,530 Starbucks Equity Value 93,348 Number of Shares Outstanding 1,496 Shares Per Share Price $62.40 per Share

To determine enterprise value using the Relative Valuation Method we obtained data on companies in the same

industry as Starbucks from Compustat and identified the comparable companies by using growth, profit margin,

and revenue as value drivers. Companies meeting the criteria of revenue greater than 2 billion, growth +10% or -‐

10% of Starbucks growth and profit margin +10% or -‐10% of Starbucks profit margin were identified as

comparables for further analysis. Chipotle Mexican Grill, Dunkin Brands Group, McDonalds Corp, Panera Bread Co,

and Yum Brands were identified as meeting the criteria and were therefore used as comparable companies.

Enterprise Value/EBITDA and Enterprise Value/Revenue adjusted median multiples were estimated from the

comparables’ multiples. These were used to arrive at an enterprise value of $54,648 million using the revenue

multiple and $78,444 million using the EBITDA multiple. The revenue multiple yielded a share price of $32.67 and

the EBITDA multiple yielded a share price of $48.58.

Valuation Method Enterprise Value Equity Value

DCF $99,109.43 million $93,348 million

Relative Valuation-‐ EBITDA multiple $78,444 million $72,683.04 million

Relative Valuation-‐ Revenue Multiple $54,648 million $48,886.96 million

As stated earlier, due to the unique set of offerings and the overall size of Starbucks the Relative Valuation Method

proves to have its flaws in this case. The Discounted Cash Flow Approach gives a much more comprehensive

valuation for Starbucks that we deem to be more accurate in the current case. Using this approach we have

concluded that Starbucks Enterprise Value is $99,109.43 million and Equity Value is $93,348 million.

STARBUCKS VALUATION REPORT 1

1. Economic Environment

1.1 Global

At the end of Starbucks 2015 fiscal year the economic environment was filled with uncertainty. With China’s financial

gyrations, further weakening of US economy and the price of oil plummeting the prospect of a global recession was

looming. Despite these uncertainties The Conference Board’s Global Economic Outlook for 20161 projects a Global

GDP growth of 2.5%. 1.2 US

With lagging GDP growth in 2015 and a slow job growth the outlook for GDP growth in 2016 will be 2% in the US,

slightly lower than 2015’s growth rate. The growth is due to domestic demand but is less than substantial due to

increasing labor costs and moderate labor productivity growth. Technology incorporation will be key in raising

profits. 1.3 EMEA

Despite increasing political risk, the outlook is positive for EMEA’s market, with modest growth expected in 2016. 1.4 CAP

The 2016 GDP growth for the CAP market is likely to stay the same as in 2015 due to declining speed of growth in

China and India. Though the growth rates are not expected to grow the population of the CAP area presents

immense opportunity for international businesses.

2. Industry Analysis:

2.1 Fast Food Industry Outlook

According to IBISWorld.com2 the $581 billion dollar Fast Food Global Industry is expected to grow at 2.6% during

2016. The fast food industry has dominated restaurant consumption in the United States and has continued to

expand globally over the past decade. Within the past several years there has been increased consumer awareness

in personal health and a corporation’s impact on the environment. The perception consumers have on each fast food

restaurant in these specific areas has a large effect on the popularity of each chain. With the addition of health and

environmentalism to the existing consumers’ criteria of consistency, speed, and affordability companies in the

sector have had to adapt in order to sustain revenue growth. 2.2 Major Competitors

Starbucks is technically in the fast food restaurant industry but falls under the food sector as well as the coffee

sector. The major competitors that align with Starbucks cross functionality include Dunkin’ Donuts, McDonald’s, and

Nestle. As Starbucks continues to grow globally McDonald’s percentage of presence in other countries is a strong

indicator for what the future store distribution will be for Starbucks.

Table 2.1-‐ Competitor data for the fiscal year 2014-‐2015 Item Starbucks Dunkin’ Donuts McDonald’s Nestle

Number of Stores 23,043 11,300 36,000 Annual Revenues $19.16 billion 0.810 billion $25.41 billion $92.83 billion

Geographic Presence (% of sales)

Americas-‐ 71.5% EMEA-‐ 6.45%

China/CAP-‐ 12.9%

US-‐ 75% Others-‐25%

US-‐31.53% Europe-‐40.37% APMEA-‐23.1%

Americas-‐44.1% EMEA-‐30.9% CAP-‐ 25%

1 https://www.conference-‐board.org/data/globaloutlook/ 2 http://clients1.ibisworld.com/reports/gl/industry/default.aspx?entid=1480


3. Company Description

Starbucks started out simply as a quick service coffee shop but has evolved to a multi-‐faceted company. With the

acquisitions of companies such as Tazo, Teavana, and La Boulange and the production of consumer-‐packaged goods

Starbucks has positioned itself to penetrate many different markets. With a wide variety of offerings: food, tea,

coffee, alcoholic beverages, Starbucks has captured much of America’s fast food industry market share and has

begun expanding globally at a more rapid pace in order to do the same internationally. Starbucks has stayed ahead of the curve in creating a welcoming experience for customers and continues to be on

the cutting edge of technology. Early investment in mobile engagement and an MSR, My Starbucks Rewards,

membership program has paid off with an increase in comparable store sales growth due to an increase in

customer loyalty. With the invention of the Keurig® machine Starbucks has created Starbucks K-‐cups that allows

customers to stay loyal outside of the stores. As consumer awareness has grown in the areas of health and

environmentalism Starbucks has been able to build its reputation as a trustworthy brand that cares about the earth

and its customers. 4. Cost of Debt (Kd)

Cost of Debt is the rate at which a company can issue debt today. A company can use various bonds, loans and other

forms of debt, so Cost of Debt is useful for giving an idea as to the overall rate being paid by the company to use debt

financing. The measure can also give investors an idea as to the riskiness of the company compared to others,

because riskier companies generally have a higher cost of debt. The cost of debt for a firm is calculated as Risk free

rate + Default premium. 4.1 Risk Free Rate

Risk free rate is the rate of an instrument like bill, note or bond which is of constant maturity and guaranteed by

government. It is the time value of money of investing in a default-‐free asset and is determined by various

macroeconomic factors. For an investment to be risk-‐free, then, it has to have no default risk and no reinvestment

risk. Time to maturity plays an important role here and has an impact on the risk free rate. Thus, the risk-‐free rates

in valuation will depend upon when the cash flow is expected to occur and will vary across time. Table 1 shows the

risk free rates across various time periods. Table 4.1 US Treasury Yields-‐

1 yr 2yr 3yr 5yr 7yr 10yr 20yr 30yr US Treasury Yield 0.23 0.61 0.89 1.36 1.74 2.04 2.48 2.87

4.2 Default Premium

To estimate the default premium for bonds, we estimated the bond rating. A bond rating is a grade given to bonds

that indicates their credit quality. Private independent rating services such as Standard & Poor's, Moody's and Fitch

provide these evaluations of a bond issuer's financial strength, or it’s the ability to pay a bond's principal and

interest in a timely fashion. Bond ratings are expressed as letters ranging from 'AAA', which is the highest grade, to

'C' ("junk"), which is the lowest grade. Different rating services use the same letter grades, but use various

combinations of upper-‐ and lower-‐case letters to differentiate themselves. To illustrate the bond ratings and their meaning, we used the Standard & Poor's format:

● AAA and AA: High credit-‐quality investment grade


● AA and BBB: Medium credit-‐quality investment grade ● BB, B, CCC, CC, and C: Low credit-‐quality (non-‐investment grade), or "junk bonds" ● D: Bonds in default for non-‐payment of principal and/or interest

To compute the cost of debt for Starbucks, the first step was to determine its synthetic debt rating. We started with

collecting the data from COMPUSTAT on debt rating, interest coverage ratio and Altman’s Z of all firms excluding

financial firms and utility firms, based on the Standard Industry Classification. 4.3 Interest Coverage Ratio

Interest Coverage Ratio is a measure of financial strength and is calculated by dividing Earnings before Interest &

Tax (EBIT) by Interest expense of the company. The formula used to calculate the Interest Coverage ratio is: Equation 4.a-‐ Interest Coverage Ratio

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐶𝑜𝑣𝑒𝑟𝑎𝑔𝑒 = !"#$!"#$%$&# !"#$%&$&

The collected data on companies was classified on the basis of the debt ratings and a descriptive statistical analysis

of Interest coverage ratio for each rating class was calculated. As shown in exhibit 5A, the format included the mean,

min, 25th percentile, median, 75th percentile and max statistics for each rating grade. Table 4.2 Starbucks Interest Coverage Ratio-‐ Starbucks 2015 2014 EBIT 3601 3081 Interest & Related Expense 70 64 Interest Coverage Ratio 51.44 48.14 4.4 Altman Z Score

Altman Z score is used to analyze the credit strength and likelihood of bankruptcy of a company. This is based on

five financial ratios, namely, (A) Working Capital/Total Assets (B) Retained Earnings/Total Assets (C) Earnings

before Interest & Tax (D) Market Value of Equity/Total Liabilities (E) Sales/ Total Assets. The data on the ratios is

extracted from company’s 10K annual report. The following formula is used that assigns specific weights to each

ratio: Equation 4.b-‐ Z-‐Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E Exhibit 5B shows the classification of Altman Z score of all the same companies as interest coverage and a

descriptive statistical analysis for each rating class was calculated. Formula 2 was then used to calculate the Altman

Z score of Starbucks-‐ Table 4.3 Starbucks Altman Z Score-‐ Starbucks Altman Z Score Numerator Denominator A = Working Capital/Total Assets $0.06 699.0 $12,446.00 B = Retained Earnings/Total Assets $0.48 5975 $12,446.00 C = Earnings Before Interest & Tax/Total Assets $0.29 3601 $12,446.00 D = Market Value of Equity/Total Liabilities $12.74 84473 6628 E = Sales/Total Assets $1.54 19163 $12,446.00 Z-‐Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E $10.88 The descriptive statistical analysis of all companies for the Interest Coverage Ratio and Altman Z score as per the

respective rating grades, and the calculated Interest coverage ratio and Altman Z of Starbucks, the debt rating was

assigned to Starbucks.


4.5 Starbuck Debt Rating-‐

Using Altman Z score as our primary indicator, the appropriate debt rating is A+ and using interest coverage, a debt

rating in the range of AA-‐ and A+ was obtained. This indicates they have a strong capacity to pay interest obligations

and principal amounts. Therefore, a rating common to both metrics was chosen, i.e. A+. The data on credit spreads

was collected from bondsonline.com, as shown in exhibit B3. For A+, the credit spreads were as follows: Table 4.4 Credit Spreads Starbucks-‐

1 yr 2 yr 3 yr 4 yr 5 yr 7 yr 8 yr 10 yr 20 yr 30 yr A+ Credit Spread 39.75 51.50 63.75 72.50 82.25 97.25 110.00 140.50 169.50 134.25

4.6 Starbucks Pretax & Post Tax Cost of Debt across maturities

As mentioned above, we add the credit spread for A+ to the risk free rate for the appropriate maturity period to

estimate the cost of debt for Starbucks. Table 5 shows the calculated cost of debt for Starbucks for various

maturities-‐ Table 4.5 Starbucks Pretax & Post Tax Cost of Debt across maturities-‐ 1 yr 2 yr 3 yr 4 yr 5 yr 7 yr 8 yr 10 yr 20 yr 30 yr Cost of Debt% (A+ Credit Spread + Risk free rate)

0.63 1.13 1.53 1.85 2.18 2.71 2.99 3.45 4.18 4.21

After Tax Cost of Debt % 0.44 0.79 1.08 1.30 1.54 1.91 2.10 2.43 2.94 2.97

5. Value of Debt-‐

When a borrowing is done by a company, it is obligated to make the timely payments of its principal and the

interest amounts. These are the cash flows associated with debt. To determine the market value of debt, we

calculate the present value of these cash flows using the cost of debt as the discount rate. The probability of default

by a company to pay its debt increases the required rate of return, that is increases the cost of debt which leads to a

fall in its market value.

Equation 5.c-‐ The formula for calculating Value of Debt is:

5.1 Starbucks Value of Long Term Debt

The cash flows referred to in this formula consists of straight debt and debt like obligations. Straight debt includes

secured and unsecured bonds, medium-‐term notes, and short-‐term financing instruments, such as lines of credit,

transaction loans and commercial paper issuances. Debt like obligations include the payments that required to be

made on a time basis for the continuous functioning of the business. One of the most significant debt like obligation

for Starbucks was lease payments. The holder of these lease contracts have precedence over equity claimants in the

event of liquidity, therefore it is crucial to account for these while deriving the equity value of the company. Using

the formula 3, the value of long term debt for Starbucks was estimated as shown in table 6-‐


Table 5.1-‐ Starbucks Value of Long Term Debt

Long term debt: Maturity Year Face Value Stated Interest rate Cost of debt Coupon Time to maturity PV

2016 400 0.88% 0.01 1.75 1 $398.49 2017 0 6.25% 0.01 0.00 2 $0.00 2018 350 2.00% 0.02 3.50 3 $339.49 2022 500 2.70% 0.03 6.75 7 $421.52 2023 750 3.85% 0.03 14.44 8 $649.59 2045 350 4.30% 0.04 7.53 30 $193.05

Value of long term debt $2,002.14

5.2 Starbuck’s Value of Lease-‐

To estimate the value of lease, we calculate the present value of the future lease payments, similar to the calculation

of value of long term debt. The difference being that there will be no principal amount to be paid at the end of the

period. We use the cost of debt as the discount rate to arrive at its present value. Therefore, the formula for the

value of firm’s lease is-‐

Equation 5.d-‐

Using this formula the Value of lease estimated for Starbucks is as shown in table 5.2

Table 5.2-‐ Starbucks Lease Payments

Operating Lease Discount rate

Financing Lease Obligation

Time to maturity

PV

2016 1032.40 0.0063 3.2 1 $1,029.14 2017 892.50 0.0113 3.2 2 $879.05 2018 739.80 0.0153 3.2 3 $716.22 2019 624.00 0.0185 3.2 4 $592.11 2020 548.90 0.0218 3.2 5 $507.74

Thereafter 1831.90 0.0345 31.1 10 $1,564.95 Value of estimated lease payments $5,289.21

5.3 Weighted Average Cost of Debt

A weighted average cost of debt was then estimated, based on the amount of PV of debt payments including lease

payments, forecasted for the year’s post 2016. The formula used to calculate this is-‐

Equation 5e-‐


The weight here are assigned on the basis of the PV of the debt and lease obligations in each year. So, the Weighted

Average Cost of Debt as per the value of debt and lease payments is as shown in Table 9-‐

Table 5.3-‐ Final Cost of Debt

Year PV of Debt PV of Lease Total PV Debt and Lease

Weighted Average Cost of Debt Weighted Cost

2016 $398.49 $1,029.14 $1,427.64 0.1958 0.63% 0.123% 2017 $0.00 $879.05 $879.05 0.1206 1.13% 0.136% 2018 $339.49 $716.22 $1,055.71 0.1448 1.53% 0.221% 2019 $0.00 $592.11 $592.11 0.0812 1.85% 0.150% 2020 $0.00 $507.74 $507.74 0.0696 2.18% 0.152% 2022 $421.52 0 $421.52 0.0578 2.71% 0.157% 2023 $649.59 $0.00 $649.59 0.0891 2.99% 0.266% 2025 $0.00 $1,564.95 $1,564.95 0.2146 3.45% 0.739% 2045 $193.05 $193.05 0.0265 4.21% 0.112%

Cost of Debt $2,002.14 $5,289.21 $7,291.35 1.0000 2.056%

5.4 Total Value of Debt and Lease Obligations

Therefore, the total Value of Debt and Lease Obligations as shown in table 7 and table 8 is $2,002.14 + $5289.21 =

$7291.35. The final weighted average cost of debt is 2.056%.

6. Cost of Equity

The cost of equity is the rate of return required by the company's equity investors (ordinary shareholders) to

compensate for the risk they undertake by investing their capital. Cost of equity can be determined using two methods:

1. Gordon model (Dividend growth model)

2. Capital Asset Pricing Model (CAPM)

We have used the Capital Asset Pricing Model (CAPM) to determine the cost of equity. The model takes into account the company’s volatility compared to the overall marketplace (beta) and calculates

the market risk premium using the expected return of the market and the expected return of a risk-‐free asset. The equation for CAPM is as follows: Ke = Rf + β (Rm -‐ Rf ) Where, Ke = Expected rate of return of the company Rf = Risk-‐free rate of return β = Company beta Rm = Return for the market as a whole (Rm -‐ Rf ) =Market risk premium 6.1 Beta (β): Beta is the asset's sensitivity to non-‐diversifiable risk (also known as systematic risk or market risk). In simple

terms, β represents how the stock is expected to move with respect to change in the market. We estimated β for Starbucks from different sources:


1. Monthly, Weekly, Daily Return: We got the data from Compustat and Bloomberg and the median was 0.94.

2. Other sources: We obtained Starbuck’s beta from Yahoo finance, Google finance, Charles Schwab,

Morningstar and the median from all this sources was 0.75.

3. Comparable companies: We estimated the beta based upon comparable firms beta by taking the following

steps:

i. Collected a group of publicly traded comparable firms, preferably in the same line of business of

Starbucks and affected by the same economic forces that affect Starbucks.

ii. Estimated the average beta for these publicly traded comparable firms.

iii. Estimated the average market value debt-‐equity ratio of these comparable firms, and calculated

the unlevered beta for the business.

βunlevered = βlevered / (1 + (1 -‐ tax rate) (Debt/Equity)) Table - 6.1.3a

Comparable Companies Levered Beta D/E Tax Rate Unlevered Beta McDonald's 0.55 216% 34.50% 0.23

Dunkin' Donuts 0.17 63% 34.50% 0.12 Chipotle Mexican Grill 0.43 0% 34.50% 0.43

Yum! Brands 0.79 145% 34.50% 0.40 Panera 0.36 68% 34.50% 0.25

Average Comparables 0.29 Starbucks 0.75

Unlevered Beta (Average) 0.52

iv. Relevered the average beta using Starbuck’s debt/equity ratio

βrelevered = βunlevered * (1 + (1 -‐ tax rate) (Company’s Debt/Equity)) Table -‐ 6.1.3b Starbuck’s Relevered Beta Unlevered Beta 0.52 D/E ratio 8.63% Tax rate 34.50% Relevered Beta 0.55 We obtained beta from all the above sources and estimated the median beta value of 0.75 for Starbucks as shown in

the table:

Table -‐ 6.1 -‐ Starbucks Beta Source Beta (β) Monthly, Weekly, Daily Return 0.94 Yahoo finance, Google finance 0.75 Relevered beta using comparables 0.55 Estimated Beta (β) 0.75 6.2 Risk free rate (Rf ):

As per Table 5.1, the rate of return for a long-‐maturity US Treasury bond (typically a 30-‐year bond) is 2.87%. Thus,

we have considered the risk free rate of 2.87% as the US treasury bond will not default. 6.3 Market Risk Premium (Rm -‐ Rf ):

With the β known, the only thing that we have to calculate is the market risk premium Rm – Rf . Market risk premium

is the return investor expect over the risk free rate. Market risk premium is trying to get longest period so that we


can cover more number of economic cycles. So, we have taken the longest horizon equity risk premium of 6.70% for

a period of 87 years from 1926-‐2013 from Ibbotson yearbook 2013. Table 6.2 -‐ Market risk premium Cost of Equity A Risk Free Rate (Rf ) 2.87% B Levered Beta (β) 0.75 C Market Risk Premium (Rm-‐Rf ) 6.70% Cost of Equity (Ke) (A+B*C) 7.87% 7. Weighted average cost of capital (WACC) The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its

security holders to finance its assets. The WACC is commonly referred to as the firm’s cost of capital. WACC is the

average after-‐tax cost of a company’s various capital sources, including common stock, preferred stock, bonds and

any other long-‐term debt. A company has two primary sources of financing -‐ debt and equity -‐ and, in simple terms,

WACC is the average cost of raising that money. This method estimates an appropriate percentage of the capital

structure coming from debt and from equity. The formula for WACC is as follows: WACC = (Wd * Kd)(1 – T) + (We * Ke) + (Wp * Kp)

Where,

Wd = proportion of debt in the capital structure; Kd = the pretax cost of debt; T = the company’s forecasted effective tax rate; We = proportion of equity in the capital structure; Ke = the cost of equity; Wp = proportion of preferred stock in the capital structure;

Kp = the cost of preferred stock; and Wd +We +Wp =1

When calculating a firm's WACC, the first step is to determine what proportion of a firm is financed by equity and

what proportion is financed by debt by entering the appropriate values into the We and Wd components of the

equation. We calculated the proportions based on the market value of equity and debt, which were calculated in

section 5.. Next, the proportion of equity We is multiplied by the cost of equity Ke; and the proportion of debt Wd is

multiplied by the cost of debt Kd, which we have calculated in section 5.3. The debt side of the equation (Wd * Kd) is

then multiplied by (1 – T) to get the after-‐tax cost of debt (there is a tax shield associated with interest). The final

step is to add the equity side of the equation to the debt side of the equation to determine WACC. Table 7.1 -‐ Weighted Average Cost of Capital WACC Calculation A Cost of Debt (Kd) 2.06% B Tax Rate (T) 34.50% C After Tax Cost of Debt Kd*(1-‐T) 1.35% D Debt / Capital (Wd) 7.95% E Cost of Equity (Ke) 7.87% F Equity / Capital (We) 92.05% WACC (A*C*D + E*F) 7.36%


8 Estimating Starbucks Enterprise and Equity Value

This section deals with applying various valuation techniques to estimate Starbucks Enterprise and Equity values.

Before we move on to the actual calculation, lets first review the concept of valuation and some of the commonly

used valuation techniques. 8.1 Valuation

The value of a company, an asset or any financial instrument is the present value of future cash flows. The premise

of valuation is that we can make reasonable estimates of value for most assets, and that the same fundamental

principles determine the values of all types of assets, real as well as financial3. 8.2 Valuation Techniques

Following are some of the most widely used valuation techniques:

i. Discounted Cash Flow (DCF) Relates the value of an asset to the present value of expected future cashflows on that asset4

ii. Relative Valuation Estimates the value of an asset by looking at the pricing of 'comparable' assets relative to a common variable like

earnings, cashflows, book value or sales5. To estimate Starbucks Enterprise and Equity value, we will use DCF and Relative Valuation in the sections to follow: 8.3 Starbucks Enterprise Value Calculation using Discounted Cash Flow Model

In discounted cashflows valuation, the value of an asset is the present value of the expected cashflows on the asset,

discounted back at a rate that reflects the riskiness of these cashflows6. Present Value concept is the fundamental

principle that guides the business decisions of all finance managers. It claims that managers should pursue

investments that have a higher present value of Future Free Cashflow: Value0 = FFCF1 + FFCF2 + FFCF3 + FFCFn + Terminal Value (eq.8.1) (1+r) (1+r)2 (1+r)3 (1+r)4 (1+r)n Value0: Value of the project to be estimated as of today FFCF: Future Free cash flow derived from executing the project Terminal Value: Value of the infinite number of cash flows r: Discount rate based on the riskiness of the project In the context of our analysis, above equation reflects that enterprise value of Starbucks is the future free cash flows

discounted at an appropriate rate. The rest of this section elaborates on the following steps in the DCF technique to

estimate Starbucks Enterprise Value: 1. Calculating Future Free Cash Flows (FFCF)

a. Estimating future free cash flows (FFCF)

b. Calculating Terminal Value (TV)

2. Determining a discount rate

3. Calculating Present Value (PV)

3 http://pages.stern.nyu.edu/~adamodar/New_Home_Page/background/valintro.htm 4 http://pages.stern.nyu.edu/~adamodar/New_Home_Page/background/valintro.htm 5 http://pages.stern.nyu.edu/~adamodar/New_Home_Page/background/valintro.htm 6 http://pages.stern.nyu.edu/~adamodar/New_Home_Page/background/valintro.htm


1. Calculating Future Free Cash Flow (FFCF) Since forecasted cash flow is based on the current (base year) Free Cash Flow (FCF) therefore, as a first step in the

process, we calculate current year (2015) FCF, which will be inflated as per our anticipated growth rates to arrive at

FFCF in subsequent years. Our calculation of current year FCF is based on an assumption that the current year is a typical one for the company,

which means that the calculated FCF is what the firm would incur under normal circumstances. Therefore, in our

estimations, we adjust each of the FCF components for any special one-‐time event happened during 2015.

a.i. Estimating Starbucks Current (Base year) Free Cash Flow (FCF) FCF is a measure of how much cash a business can generate through its operations after accounting for capital

expenditures and changes in working capital requirements. FCF is important because it allows a company to pursue

opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions,

pay dividends and reduce debt7. From the definition,the formula for FCF can be deduced as below: FCF = NOPAT – Net Capex -‐ Change in NWC (eq. 8.2) Now, we will assess each of the components to estimate Starbucks base year FCF.

Net Operating Profit After Taxes (NOPAT)

Investopedia defines NOPAT as “Net operating profit after tax (NOPAT) is a company’s potential cash earnings if

its capitalization were unleveraged (that is, if it had no debt). NOPAT is frequently used in economic value added

(EVA) calculations. Using equation 3, we calculate Starbucks NOPAT for 2015 in Table 8.1. NOPAT= Adjusted EBIT 8+/-‐ One time cash flow + Any financing expense that is listed as an operating expense but is

actually it is a financing expense + Any investment expense listed as an operating expense – Taxes (eq. 3) Table 8.1: Starbucks NOPAT for Year Ended September 2015 Millions USD Operating Income (Loss) 3,601.0 Add: Lease Expense 117.5 Add: Marketing Expense 351.5 Adjusted EBIT 4,070.0 Less: Tax Expense* 1,204.7 NOPAT 2,865.3 * Tax rate: 29.60%

Net Capital Expenditure (Net Capex)

(Sarin, Shapiro, and Iyer) define Net Capex as “Net CAPEX includes funds used to acquire or upgrade physical assets

such as property, industrial buildings, or equipment, net of depreciation. Acquisitions are also appropriately

included in net CAPEX, even if they are funded with stock.” We use equation 4 to calculate Starbucks Net Capex in

Table 8.2. Net Capex = Capex – Depreciation + Acquisition*Normalize Value + Changes in the value of leases + Any investment

expense listed as operating expense (eq. 8.4)

7 http://www.investopedia.com/terms/f/freecashflow.asp 8 Adjusted EBIT = Revenue – Cost of Goods Sold – Selling & Administration expense


Table 8.2: Starbucks Net Capital Expenditures for 2015 Millions USD Capital Expenditures 1,303.70 Less: Depreciation 893.9 Add: Acquisition Expense -‐284.3 Add: Change in lease value 903 Add: Investment expenses listed as Operating Expense 351.5 Net Capex 1,380.4

Changes in Net Working Capital

Net working Capital, an aggregate amount of current assets and all current liabilities, reflects the availability of

liquid assets to a firm. An important point to note is that we include minimum cash required to operate the business

in our calculation of NWC. A change in the NWC over a period shows a firm’s need for cash to meet the working

capital requirements. It means that an increase in NWC would call for additional cash into the operations of the

business leaving less amount for the stakeholders and similarly, a decrease in NWC would mean vice versa. Using

equation 5, we calculate the Starbucks Net Working Capital for 2014 and 2015 to arrive at the change in NWC over

one year period. Table 8.3 shows calculations. Net Working Capital: Current Assets9 -‐ Current Liabilities (eq. 8.5) Table 8.3: Starbucks Changes in Net Working Capital for the year 2014 – 2015 Millions USD Add: Incr. in Inventory 1. 215.0 Add: Incr. in A/R 88.0 Less: Incr. in A/P 150.5 Add: Incr. in Cash -‐5.3 Net Increase in Working Capital 147.2

Starbucks Current (Base Year) Free Cash Flow

Using all components of FCF, we arrive at the current Free Cash flow of Starbucks. Table 8.4 shows the calculated

numbers as of September 2015. Table 8. 4: Starbucks Free Cash Flow for the Year Ended September 2015 Millions USD NOPAT 2,865.3 Less: Net Capex 1,380.4 Less: Change in Net Working Capital 147.2 Free Cash Flow 1,337.74

a.ii. Estimating Starbucks Future Free Cash flows Having current year’s FCF, we now forecast the FFCF following steps mentioned below: i. Determining an appropriate forecasting period ii. Normalizing NOPAT, Net Capex, and Change in Working Capital to Revenue ratios iii. Forecasting Revenue iv. Calculating Forecasted FFCF

9 Current Assets = Cash + Accounts Receivable + Inventory – Accounts Payable


i. Determining an appropriate forecasting period

For our analysis, we assume that Starbucks growth rate will be normalized after year 5. It means that after 2020 the

company would follow a constant growth rate into infinity. Following this assumption, our forecasting will be for

the next five years starting from 2016 until 2020.

ii. Normalizing NOPAT, Net Capex, and Change in Working Capital to Revenue Ratios

We now calculate the historical ratio of each of the FCF component (i.e. NOPAT, Net Capex, and Change in Net

Working Capital) to respective year’s revenue for the last three years (2013 – 2015). These historical common size

ratios will help us in forecasting each of the components to revenue ratio in subsequent years. Table 8. 5 shows

historical and forecasted ratios.

Table 8.5: Starbucks Common Size Ratios Historical Ratios Forecasted Ratios 2013 2014 2015 2016 Subsequent Ratios NOPAT (as a ratio of NOPAT/Sales) 12.94% 13.83% 14.95% 13.91% Kept constant Change in NWC (as % of Revenue change) -‐6.81% -‐1.14% 5.42% 2.14% Kept Constant Net Capital Expenditures (as a % of revenue)

12.44% 6.44% 7.20% 8.69% Decreased by 2% each year to 0% in 2020

Tax rate 32.60% 34.60% 29.60% 34.50% Kept Constant

iii. Forecasting Revenue

We use equation 6 as the revenue forecast model to derive Starbucks revenue growth rate. Table 8.6 shows detail

calculations: Sales (t+1) = (Sales/No. of stores) * [{(No. of existing stores) +(No. of new stores/2)} * {(1+ growth in same store

sale)}] (eq. 8.6)

Table 8.6: Starbucks Revenue Forecast Model -‐ 2016 Millions USD Sales in 2015 19,162.7 No. of stores in 2015 23,043 No. of new stores (Forecasted)* 180010 Expected Growth in same store sale 7%11 Expected Sales in 2016 21,304.93 Sales Growth 2015-‐2016 11.18% New stores opened in China mainly drove revenue in 2015. The growth in number of stores in China is not expected

to grow at a consistently high rate as evident by the revenue growth, which decreased from 22% to 9% in china in

the last five years, therefore our revenue forecast is based on straight-‐line depreciation of 11.18% through 2020.

Table8. 7 shows revenue growth rates and revenue for the forested period.

Table 8.7: (Millions USD) 2016 2017 2018 2019 2020 Revenues 21,305.26 23,387.06 25,343.04 27,105.81 28,609.60 Revenue Growth 11.18% 9.77% 8.36% 6.96% 5.55% 10 Based on management’s forecast on new stores to be opened between 2015 & 2016. By 2nd Quarter 2016, 878 new stores have been opened as per Q2 earnings call. 11 Based on last five years (2011-‐2015) average of same store sales.


Calculating Expected Future Free Cash flow: We now multiply the normalized ratios determined in step 2 with the revenues calculated in step 3 to forecast FFCF

for the forecasted period. Table 8.8 shows the forecasted values:

Table 8.8: Starbucks Forecasted FFCF Millions USD 2016 2017 2018 2019 2020 NOPAT 2,963.37 3,252.93 3,524.99 3,770.17 3,979.34 Less: Net Capex 1,852.36 1,550.56 1,173.38 712.88 0.00 Less: Increase in Net Working Capital

45.85 44.55 41.86 37.72 32.18

Free Cash Flows 1,065.17 1,657.81 2,309.75 3,019.57 3,947.15 Calculating Terminal Value: (Chacko and Evans, 2014) state that Terminal value can be calculated using several methods as follows: Perpetuity growth method: We can arrive at the terminal value by determining the growing perpetuity value of

the infinite sum of discounted free cash flows. This approach works well in the situation where the variability of the

free cash flows decreases and the free cash flows settle into a smooth growing pattern. It also aligns with the

characteristic of a firm being a “Going Concern”.12 Multiples Method: The concept behind this approach is to calculate a terminal value by simply computing a market

value for the asset side of the balance sheet at the terminal value point. This market value is determined by looking

at the market values of comparable assets today and proportionately imputing a similar valuation for the terminal

value of the asset we are trying to value13. Liquidation Method: To use liquidation value as the terminal value, one assumes that the asset being valued is

liquidated at the end of the nth year. Where nth year being the last forecasted year at the end of which, the asset

being valued is expected to be sold at a price equal to the Terminal Value.

b. Estimating Starbucks Terminal Value using Perpetuity Growth Method For our analysis, we will use equation 7 i.e. Perpetuity Growth formula to calculate Starbucks Terminal Value: Terminal Value2020 = FFCF2020 * (1+g) (eq. 8.7) (r – g) We can list steps for terminal value calculation as follows:

i. Estimating Expected future Cashflow as at 2020

For calculation of Terminal Value in nth year, we will estimate expected future free cash flow at year n-‐1. It means

that for our calculation of Starbucks Terminal Value at the end of 2020, we will use forecasted FFCF in year 2020 i.e.

$3,947.15 million. This number is already calculated in Table 8.

12 http://pages.stern.nyu.edu/~adamodar/New_Home_Page/littlebook/terminalvalue.htm 13 http://pages.stern.nyu.edu/~adamodar/New_Home_Page/background/valintro.htm


ii. Determining Long Term Growth Rate

This is the rate at which the firm’s cash flows are expected to grow forever therefore we assume this rate to be the

long term nominal growth rate of US economy. Using US economic data published on IMF website, we conclude the

long term US growth rate to be 4.114%, which includes 1.981% real GDP and the remaining to be inflation.

iii. Determining the Discount Rate to be used

the discount rate used to calculate the terminal value is based on the riskiness of the cash flows of the company. For

this analysis, we will use Weighted Average Cost of Capital (WACC) as determined in Section 7. Following above-‐mentioned steps, the calculate Starbucks Terminal Value as at the end of 2020. Table 8.9 shows

calculation: Table 8.9: Starbucks Terminal Value Calculation Millions USD Forecasted FFCF in 2020 3,947.15 Long Term Nominal Growth Rate (g) 4.114%, Discount Rate (r) 7.36% Terminal Value 2020 128,011.887 Year wise forecasted FFCF from 2016 through 2020 (from Table 8) and Terminal Value at the end of 2020 (from

Table 9) are aggregated to arrive at Starbucks total forecasted FFCF.

2. Determining Discount Rate The next step in the process is to identify an appropriate Discount Rate. As mentioned in the Section 7, we will use

WACC to discount the estimated cash flows and arrive at the Present Value.

3. Calculating Present Value of Future Free Cash Flows Using the forecasted FFCF estimated in step 1 (Tables 8&9) and the discount rate determined in section 7, we apply

equation 1 to arrive at Starbucks Enterprise value by estimating the Present Value of its FFCF. Table 8.10 shows the

final calculation of Starbucks Enterprise Value:

Table 8.10: Starbucks Present Value of FFCF Millions USD 2015 2016 2017 2018 2019 2020 Present Value of Free Cash Flows 992.19 1,438.43 1,866.79 2,273.28 2,768.02 Present Value of Terminal Value 89,770.73 Starbucks Enterprise Value 99,109.43

4. Estimating Starbucks Equity Value Having estimated Starbucks Enterprise Value, we can now estimate Starbucks Equity Value using Equation 8. The

Equity Value is divided by the Number of Shares Outstanding as at 30th September 2015 to estimate Per Share

Value. Table 8.11 shows calculations. Equity Value = Enterprise Value – Debt Value + Cash (eq. 8.8)


Table 8. 11: Starbucks Equity and Per Share Value as at September 2015 Millions USD Starbucks Enterprise Value 99,109.43 Less: Debt Value 7,291.35 Add: Cash 1,530 Starbucks Equity Value 93,348 Number of Shares Outstanding 1,496 Shares Per Share Price $62.40 per Share

9. Relative Valuation:

Relative valuation also called valuation using multiples is the notion of comparing the value of an asset or company

to the market values of comparable assets or companies. The values are compared using certain financial ratios. The following steps are employed in relative valuation to estimate the value of Starbucks: 9.1. Creation a master list of comparables 9.2 Identification of value drivers 9.3 Creation of the elimination and acceptance matrix 9.4 Estimation of Valuation ratios for valuation matrix 9.5 Adjusting for differences 9.6 Estimation of the enterprise value and equity value of Starbucks 9.1 Creation of master list of comparables

The master list of comparables is created by including all the companies that are in the same industry as Starbucks.

Compustat is a database, which provides financial information and research on more than 7500 publicly held

companies. Using this database, companies in the same industry as Starbucks were identified with the help of the

Standard Industrial Classification (SIC) code. Analyst reports, 10Ks and hoovers.com are also good sources to determine comparables. These comparables as

shown in Table-‐9.1 below were also included in the master list.

Table-‐9.1

Morningstar Argus S&P Capital IQ McDonald's Corp McDonald's Corp Biglari Holdings Panera Bread Panera Bread Domino's Pizza

Dunkin' Brands Group Dunkin' Brands Group McDonald's Corp Yum Brands Jack in the Box Chipotle Mexican Grill Papa John's Intl Domino's Pizza Yum Brands Cracker Barrel Country Store Wendy's Co Darden Restaurants

9.2 Identification of value drivers

Value drivers are used for comparing the various companies in the master list to arrive at the final acceptable list of

comparables for relative valuation. It shows what the comparability is based on. The value drivers that we have


used are growth, size (as reflected by revenue) and profitability (as reflected by profit margin). The value drivers

for all the companies in the master list of comparables were determined from Compustat. 9.3 Creation of the elimination and acceptance matrix

We then framed criteria for inclusion of companies in the acceptance matrix for further analysis. These criteria are

as below: 1. Growth: + 10% or – 10% of the expected growth of Starbucks 2. Profit Margin: +10% of -‐10% of Starbucks’ profit margin 3. Revenue: Greater than 2 billion Based on these criteria, the elimination and acceptance matrix was created as shown in Table-‐9.2 below: Table-‐9.2:

Comparable Profit Margin Acceptance

Revenue Acceptance

Analyst views Growth Score

McDonald's Y Y Y N 3 Dunkin's Brand Group Y Y (Close) Y N 3 Chipotle Y Y Y N 3 Yum Brands N Y Y N 2 Panera N Y Y N 2 Restaurant Brands Inc. Y N N N 1 Wingstop Inc. Y N N Y 2 The shortlisted comparables for further analysis were Chipotle Mexican Grill Inc, Dunkin Brands Group Inc,

McDonalds Corp, Panera Bread Co and Yum Brands Inc. 9.4 Estimation of Valuation ratios for valuation matrix

We estimate two valuation ratios for the comparables identified:

9.4.1 Enterprise Value/EBITDA This is the most widely used valuation multiple based on enterprise value to determine the value of company. The

advantage with this multiple is that it is capital structure neutral and so it can be used to directly compare

companies with different levels of debt.

9.4.2 Enterprise Value/Revenue This compares a company’s enterprise value with its revenue. Comparison of companies using this multiple gives an

indication of the relative financial health of the company under study. The EV/Revenue multiple should be used for

comparing companies in the same industry only. The valuation ratios were estimated for the shortlisted comparables and the valuation matrix was constructed as

shown in Table-‐9.3 below:


Table-‐9.3

Comparable Revenue EBITDA Enterprise Value

Revenue Multiple

EBITDA Multiple

Chipotle Mexican Grill Inc 33 32.428 467 14.15 14.40 Dunkin Brands Group Inc 2842 258.399 3776 1.33 14.61 McDonalds Corp 1 -‐4.189 21 14.29 -‐4.95 Panera Bread Co 404 18.915 769 1.91 40.68 Yum Brands Inc 0 -‐1.042 47 2.57 -‐44.66 Median Multiples 2.57 14.40

Using the median multiples in the valuation matrix, the enterprise value and equity value of Starbucks was

estimated as shown in Table-‐9.4 below:

Table-‐9.4 (in millions) Values Revenue Multiple EBITDA multiple Enterprise Value 49,232.85 70,670.76 Equity Value 43,471.35 64909.26

9.5 Adjusting for differences

Since comparability is not perfect, we make adjustments to the median and arrive at adjusted revenue and EBITDA

median multiples as shown in Table-‐8.5 below: Table-‐9.5 (in millions) Factors SBUX Median Comparable Adjustments for Median Revenue 19163 4443 10.00% Profit Margin 0.1257 0.1257 0.00% Growth 14% 13% 1.00% Total Adjustment 11.00% Adjusted Revenue Median 2.85 Adjusted EBITDA Median 15.99

9.6 Estimation of the enterprise value and equity value of Starbucks

Based on the adjusted revenue and EBITDA median multiples, the enterprise value and equity value of Starbucks were estimated as shown in Table-‐9.6 below: Table-‐9.6 (in millions) Values Revenue Multiple EBITDA multiple Enterprise Value 54,648.46 78,444.54 Equity Value 48,886.96 72683.04


References

Erumban, Abdul A. "Global Economic Outlook 2016 -‐ Key Findings | The Conference Board." Global Economic Outlook 2016 -‐ Key Findings | The Conference Board. The Conference Board, 01 May 2016. Web. 01 June 2016. Sena, Matt. "Fast Food Industry Analysis 2016 -‐ Cost & Trends." Fast Food Industry Analysis 2016 -‐ Cost & Trends. Franchise Help, n.d. Web. 01 June 2016. Alvarez, Andrew. "Fresh Choices: Healthy Menu Options and Expansion into Emerging Markets Will Drive Industry Growth." IBISWorld Global. N.p., Apr. 2016. Web. May 2016. Art and Science of Valuation by Atulya Sarin, Alan C. Shapiro, and Gopal Iyer


Appendix –Exhibits

Exhibit 1: Starbucks Valuation Model

(Millions USD)

Historical Forecast

2012 2013 2014 2015 2016 2017 2018 2019 2020

Operating Forecast

Operating Cash Flow

Net Revenues 13,300.00 14,892.00 16,448.00 19,163.00 21305.26 23387.06 25343.04 27105.81 28609.60

Operating Income (loss) 1787 -‐325 3081 3601

Key Balance Sheet Data

Working Capital

Cash 1,189.0 2,576.0 1,708.0 1,530.0

Inventory 1,242.0 1,111.0 1,091.0 1,306.0

Accounts Receivables 486.0 561.0 631.0 719.0

Accounts Payable 398.0 492.0 533.7 684.2

Capital Expenditures

Capital Expenditures 856.2 1151.2 1160.9 1303.7

Depreciation 621.4 655.6 709.6 893.9

Disounted Cash Flow Inputs

Sales Growth Revenue 11.97% 10.45% 16.51% 11.18% 9.77% 8.36% 6.96% 5.55% Change in Sales 1600 1,592.00 1,556.00 2,715.00 2142.26 2081.80 1955.97 1762.77 1503.78 Common Size Ratios NOPAT (as a ratio of NOPAT/Sales) 0.1294 0.1383 0.1495 0.1391 0.1391 0.1391 0.1391 0.1391 Change in NWC(as % of Revenue change)

-‐6.81% -‐1.14% 5.42% 2.14% 2.14% 2.14% 2.14% 2.14%

Net Capital Expenditures (as a % of revenue)

12.44% 6.44% 7.20% 8.69% 6.63% 4.63% 2.63% 0%

Other Key Ratios Tax rate 34.50% 32.60% 34.60% 29.60% 34.50% 34.50% 34.50% 34.50% 34.50% Discounted Cash Flow Valuation

WACC 7.36% Cost of Debt 2.06% Cost of Equity 7.87% Perpetuity growth 1.98%(GDP) +2.163%(Inflation)

4.14%

Net Operating Profit After Tax Adjusted EBIT Litigation Expense 0 2784.1 -‐20.2 0 Lease Expense 83.48 94.29 101.93 117.53 Marketing Expense 277.9 306.8 315.5 351.5 Adjusted EBIT 2148.38 2860.19 3478.23 4070.03 Tax Expense 741.19 932.42 1203.47 1204.73 NOPAT 1407.19 1927.77 2274.77 2865.30 2963.37 3252.93 3524.99 3770.17 3979.34


*NOPAT to Sales ratio is kept constant at an average of last three years. *The ratio of Change in NWC to change in sales is kept constant at the average of the last two years. *The Net Capex as a % of sales in 2016 is the average of last three years %, which gradually decreases to 0 at the end of 5 years.

Less: Net Capital Expenditures Capital Expenditures 856.20 1,151.20 1,160.90 1,303.70 Depreciation 621.4 655.6 709.6 893.9 Aquisition Expense 129.1 610.4 0 -‐284.3 Change in lease value 439 293 903 Investment expenses listed as opex

306.8 315.5 351.5

Net Capex 1,851.9 1,059.9 1,380.4 1852.36 1550.56 1173.38 712.88 0.00 Less: Increase in Working Capital Incr. in Inventory 276 -‐131.0 -‐20.0 215.0 Incr. in A/R 100 75.0 70.0 88.0 Incr. in A/P -‐142 94.0 41.7 150.5 Incr. in Cash 1.23 41.6 -‐26.0 -‐5.3 Increase in Working Capital

519.23 -‐108.4 -‐17.7 147.2 45.85 44.55 41.86 37.72 32.18

Free Cash Flows 184.27 1232.57 1337.74 1065.17 1657.81 2309.75 3019.57 3947.15 Terminal Value 128011 Valuation Discount Factor @ WACC 7.36% 0.931 0.868 0.808 0.753 0.701 Present Value of Free Cash Flows 992.19 1438.43 1866.79 2273.28 2768.02 Present Value of Terminal Value 89770.73

PV Cash Flows Forecast 9,339 Enterprise Value 99,109.43

Terminal 89,771 Less: Net Debt $7,291.35 PV Cash Flows $99,109 Add: Cash $1,530.00

Equity Value $93,348 Number of shares 1496

Price Per Share $62.40


12.1 Exhibit-‐ 5A-‐ Interest Coverage Ratio Interest Coverage Ratio

Debt Rating Mean Min 25th Percentile Median 75th Percentile Max AAA 32.79 8.06 26.73 34.51 40.57 54.09 AA+ 69.64 2.56 36.1 69.64 103.18 136.72 AA 113.78 9.64 12.44 19.64 83.09 708.21 AA-‐ 104.2 0.61 16.71 23.73 99.37 839.67 A+ 94.12 5.2 11.72 19.61 36.62 1606.8 A 18.23 -‐10.14 9.8 14.09 20.11 89.39 A-‐ 20.58 3.39 7.99 13.07 22.68 110.52

BBB+ 12.35 -‐10.82 5.25 9.27 14.74 94.51 BBB 11.91 -‐5.5 4.92 7.69 12.02 142.3 BBB-‐ 11.62 -‐7.93 3.68 6.83 11.21 182 BB+ 7.99 -‐6.43 3.74 5.63 9 73.73 BB 23.68 -‐6.49 2.73 4.12 6.31 2132.37 BB-‐ 0.17 -‐16.9 -‐0.23 0.57 1.21 24.46 B+ 3.35 -‐3.9 1.46 2.32 4.21 22.81 B 1.39 -‐40.27 0.59 1.3 2.15 35 B-‐ 0.17 -‐16.9 -‐0.23 0.57 1.21 24.46

CCC+ -‐0.67 -‐5.48 -‐1.58 0.02 0.61 1.04 CCC -‐1.09 -‐4.63 -‐3.21 0 0.75 1.34 CCC-‐ 2.06 -‐5.51 0 1.87 4.99 8.71 CC -‐0.54 -‐0.54 -‐0.54 -‐0.54 -‐0.54 -‐0.54 D -‐2.06 -‐6.78 -‐3.21 -‐1.27 -‐0.12 1.07


12.2 Exhibit 5B-‐ Altman Z-‐Score

Altman's Z Score Debt Rating Mean Min 25th Percentile Median 75th Percentile Max

AAA 3.601 1.07 3.17 4.07 4.49 5.18 AA+ 2.99 0.943 1.96 2.99 4.01 5.04 AA 3.2 1.04 1.87 2.56 3.49 10.41 AA- 3.54 1.15 1.63 3.24 3.71 9.91 A+ 3.83 1.03 1.4 3.25 5.18 10.36 A 3.77 0.93 2.22 3.27 4.16 12.61 A- 3.9 1.01 1.7 3.39 4.94 16.34

BBB+ 3.11 -0.23 1.47 2.73 4.5 9.99 BBB 2.88 0.11 1.67 2.5 3.88 10.17 BBB- 2.77 -0.77 1.6 2.6 3.73 9.03 BB+ 2.92 -9.92 1.81 2.67 3.64 11.57 BB 2.4 -1.01 1.4 2 2.84 11.46 BB- 1.92 -0.4 1.07 1.69 2.41 8.13 B+ 2.01 -1.45 1.1 1.75 2.51 9.31 B 1.01 -9.18 0.55 1.01 1.64 12.18 B- 1 -1.96 0.36 0.97 1.63 3.76

CCC+ 0.59 -1.77 -0.09 0.85 1.58 2.46 CCC 0.43 -0.25 0 0.33 0.59 1.59 CCC- 0.5 -1.04 -0.56 0.82 1.43 1.8

CC 0.23 0.23 0.23 0.23 0.23 0.23 D -0.59 -2.92 -0.96 -0.26 0.11 1.09

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