Starbucks has 2 million shares of common stock outstanding. The common stock jus

Question

Starbucks  has 2 million shares of common stock outstanding. The common stock just paid a dividend of $1. It is expected to grow by 30% per year for the next 2 years. After that, the dividend is expected to grow at a constant rate of 5% per year forever. The market value of debt is $20 million. The current risk-free rate is 3% and the market premium is 10%. The company’s equity beta is 1.4 and the corporate tax rate is 35%.

What is Starbuck's current stock price per share?

What is the company’s WACC?

Suppose you have a project that’s going to cost $7 million initially, and it will generate cash flow of $1.5 million every year for 6 years, starting from year 3. Assume the project is as risky as the firm, will you take it?

Explanation / Answer

Year Nature Cashflow PV Factor @ 17% Discounted Cashflow A B A*B 1 Dividend           1.30 0.8547                1.11 2 Dividend           1.69 0.7305                1.23 2 Market Price at the end of Year 2         14.79 0.7305              10.80 Current Market Price              13.15 Re = Risk Free Rate + Market Premium * Beta Re = 17% (3% + 10% * 1.4) Constant growth rate = g = 5% after 2 years Dividend Calculations Year Calculation Amount 1 D1 = 1 * 1.3           1.30 2 D2 = D1 * 1.3           1.69 3 D3 = D2 * 1.05           1.77 Market Price at the end of Year 2 = D3 / (Re - g) = 1.77 / (0.17 - 0.05) = 14.79 WACC Cost of Debt = Risk Free Rate (Assuming) Post tax Cost of Debt = Cost of Debt * (1 - tax rate) = 3% * (1-0.35) = 1.95% Cost of Equity = 17% WACC = Kd*Wd + Ke*We where, Wd and We are weights of debt and equity capital Value of Debt = $20m Value of Equity = $13.15 * 2m = $26.30m or, WACC = 1.95% * 20/(20+26.30) + 17% * 26.30/(20+26.30) = 1.95% * 20/46.30 + 17% * 26.30/46.30 = 0.84% + 9.66% = 10.50% Initial Outflow = $7m Cash Inflow = $1.5m for years from 3rd year PV of Inflow at the third year = $1.5m * Annuity Factor at 10.5% for 6 years = $1.5m * 4.2922 = $6.4383m PV of $6.4383m today = 6.4383 / 1.105^2 = $5.273m NPV = $5.273m - $7m = $-1.727m Since the project results in negative NPV, it will not be accepted

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