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Chapter 13
Valuation: Earnings-Based Approach
13-18
in whole or in part.
Part II—Sensitivity Analysis and Recommendation
Scenario 1: If we assume that Walmart’s long-run growth will be 2%, not 3%
as above, and that Walmart’s required rate of return on equity is 1 percentage
tical to the current market price of $69.09.
Scenario 2: If we assume that Walmart’s long-run growth will be 4%, not 3%
8.0%), the resulting share value estimate increases to $120.72 per share. That
amount is 39% greater than our base case estimate of $86.88 and 75% greater
than the current market price of $69.09.
h. At the start of Year +1, Walmart’s share price was $69.09. Our baseline share
roughly $69 and therefore would have recommended a buy.
i. Our baseline share value estimate for Walmart in Solution g of Problem 11.14
from Chapter 11 using the dividends valuation approach is $86.88. Similarly,
Chapter 13
Valuation: Earnings-Based Approach
13-19
Exhibit 13.D
Residual Income Valuation Sensitivity Analysis for Walmart Stores
(Problem 13.20)
Residual Income Valuation Sensitivity Analysis:
Long-Run Growth Assumptions
86.88 0% 2% 3% 4% 5% 6% 8% 10%
Discount 5% 125.13 182.65 254.55 470.24
Rates: 6% 104.21 137.48 170.75 237.29 436.92
7% 89.27 110.37 128.83 159.60 221.13 405.74
8% 78.08 92.29 103.66 120.72 149.15 206.00
Chapter 13
Valuation: Earnings-Based Approach
13-20
in whole or in part.
Integrative Case 13.1: Starbucks
Residual Income Valuation of Starbucks’ Common Equity. This is an extensive
integrated case that connects all of the topics of the text. In this portion of the case, we
connect the valuation techniques described in Chapter 13 to the financial statement
forecasts we developed in Chapter 10 for Starbucks, the dividends valuation approach
presented in Chapter 11, and the free cash flows valuation approach in Chapter 12. This
case also is used in Chapter 14 to demonstrate the valuation approach in that chapter.
Note that these analyses have been prepared using FSAP. The FSAP file containing these
analyses is available for download by instructors (not students) from the book’s website
In Integrative Case 10.1, we projected financial statements for Starbucks for Years +1
through +5. In this portion of the Starbucks Integrative Case, we apply the techniques in
Chapter 13 to compute Starbucks’ required rate of return on equity and weighted-average
cost of capital and estimate Starbucks’ share value based on the residual income valua-
tion approach. At the end of the case, we conduct sensitivity analysis, varying key
valuation parameters and assessing the effects on share value. We also compare our value
estimate to Starbucks’ share price at the time of the case to develop an investment
recommendation.
The case data indicate that the market equity beta for Starbucks at the end of 2012 is
0.75. Assume that the risk-free interest rate is 3.0% and the market risk premium is 6.0%.
Starbucks has 749.3 million shares outstanding at the end of 2012. At the start of Year
+1, Starbucks’ share price was $50.15.
Part I—Computing Starbucks’ Share Value Using the Residual Income Valuation
Approach
a. Following the CAPM, Starbucks faces a required rate of return on equity capital of
7.50% at the end of 2012. This rate is computed as follows:
b., c., d., e., and f.
Exhibit 13.E presents the excerpts from FSAP for the valuation of Starbucks based on
projected residual income. The first rows of the table present the computations for
Starbucks’ projected residual income for Years +1 through +6. The right-most
in Chapter 11 and the free cash flows model in Chapter 12.
Chapter 13
Valuation: Earnings-Based Approach
13-21
Exhibit 13.E
Residual Income Valuation for Starbucks
(Integrative Case 13.1)
Continuing
1 2 3 4 5 Value
Residual Income Valuation Year +1 Year +2 Year +3 Year +4 Year +5 Year +6
Comprehensive Income Available for Common Shareholders 1,573.5 1,793.3 2,038.3 2,302.8 2,871.4 2,957.6
Lagged Book Value of Common Shareholders’ Equity (at t – 1) 5,109.0 5,499.1 6,408.7 7,122.7 8,085.9 9,861.5
Required Earnings 383.2 412.4 480.7 534.2 606.4 739.6
Chapter 13
Valuation: Earnings-Based Approach
13-22
b. and c.
Projected residual income amounts for Starbucks in Years +1 to +6 are as follows:
Residual Income Valuation Year +1 Year +2 Year +3 Year +4 Year +5 Year +6
Lagged Book Value of Common
Shareholders’ Equity (at t – 1) $5,109.0 $5,499.1 $6,408.7 $7,122.7 $8,085.9 $9,861.5
d. The data in Exhibit 13.E show that the sum of the present value of residual income
f. The data in Exhibit 13.E show the following computations:
(1) The sum of the present value of residual income is $40,789.9 million ($6,458.0
million + $34,331.9 million).
(2) Adding the beginning book value of common shareholders’ equity indicates that
Chapter 13
Valuation: Earnings-Based Approach
13-23
Part II—Sensitivity Analysis and Recommendation
g. The data in Exhibit 13.F show the results of various sensitivity analysis scenarios,
varying discount rates, and growth rates.
Scenario 1: If we assume that Starbucks’ long-run growth will be 2%, not 3% as
of $50.15.
Scenario 2: If we assume that Starbucks’ long-run growth will be 4%, not 3% as
above, and that Starbucks’ required rate of return on equity is 1 percentage point
lower than the rate computed using the CAPM in Solution a (that is, 6.50%), the
h. At the start of Year +1, Starbucks’ share price was $50.15. Our baseline share value
estimate is $63.55, implying that Starbucks’ shares are under-priced by roughly 27%.
Sensitivity analysis reveals that slight variations in the long-term growth rate and
discount rate can cause the share value estimate to vary between $45 per share (10%
i. The value estimates we have obtained in this case using the residual income valuation
11. You can use this insight to reinforce that all three valuation approaches should be
equivalent.
Chapter 13
Valuation: Earnings-Based Approach
13-24
in whole or in part.
Exhibit 13.F
Residual Income Valuation Sensitivity Analysis for Starbucks
(Integrative Case 13.1)
Residual Income Valuation Sensitivity Analysis:
Long-Run Growth Assumptions
63.55 0% 2% 3% 4% 5% 6% 8% 10%
Discount 5% 68.44 104.48 149.53 284.68
Rates: 6% 55.89 76.88 97.87 139.84 265.78
6.5% 51.08 67.70 83.14 110.92 175.75 499.87
7.50% 43.43 54.41 63.55 77.93 103.80 164.17
