Chapter 14
Valuation: Market-Based Approaches
14-20
in whole or in part.
(3) Reverse engineering suggests that the market has priced PepsiCo shares to
yield a higher rate of return than Coca-Cola shares (8.696% versus 8.372%,
respectively, holding long-run growth constant at 3.0%).
respectively).
14.24 Valuation of Walmart Using Market Multiples. This is an extensive integrated
problem that connects the topics of Chapter 14 to those of Chapters 10–13 using
Walmart Stores, Inc. 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 for instructors: Go to instructor’s resources
In this problem, we estimate cost of equity capital for Walmart and use the
value-to-book valuation approach to estimate Walmart’s share value and make a
recommendation on Walmart stock based on this analysis. We also examine the
value-earnings ratio, the price-earnings ratio, price differentials, and reverse
engineering.
The market equity beta for Walmart at the end of 2012 is 1.00. Assume that the
risk-free interest rate is 3.0% and the market risk premium is 6.0%. Walmart has
3,314 million shares outstanding at the end of 2012. At the end of 2012,
Walmart’s share price was $69.09.
Part I—Computing Walmart’s Value-to-Book Ratio Using the Value-to-Book
Valuation Approach
a. Following the CAPM, Walmart faces a required rate of return on equity capi-
Exhibit 14.B presents the excerpts from FSAP for the valuation of Walmart
based on projected residual ROCE and the value-to-book approach. The first
rows of the table present the computations for Walmart’s projected residual
Chapter 14
Valuation: Market-Based Approaches
14-21
in whole or in part.
Exhibit 14.B
Value-to-Book Model Valuation for Walmart Stores
(Problem 14.24)
Continuing
RESIDUAL INCOME VALUATION 1 2 3 4 5 Value
Market-to-Book Approach Year +1 Year +2 Year +3 Year +4 Year +5 Year +6
Comprehensive Income Available for Common Shareholders 17,666.5 18,415.7 19,195.4 20,006.7 20,851.0 21,476.5
Chapter 14
Valuation: Market-Based Approaches
14-22
in whole or in part.
b. and c.
Projected residual ROCE amounts for Walmart in Years +1 to +6 are shown in
the exhibit.
equity.
e. The data in the exhibit indicate that projected residual ROCE in Year +6 will
be 17.2%. Using the 9.0% required rate of return on common equity from So-
lution a as a discount rate and the 3.0% long-run growth rate from Solution c,
f. We compute Walmart’s value-to-book ratio as of the end of 2012 with the fol-
lowing three steps: (1) The total sum of the present value of all future residual
g. Walmart’s market-to-book ratio as of the end of 2012 equals 3.00 [($69.09 per
ket.
h. Using the value-to-book ratio, we project a $86.88 value per share of common
equity in Walmart (3.771 value-to-book ratio × $76,343 million book
value/3,314.0 million shares).
Part II—Analyzing Walmart’s Share Price Using the Value-Earnings Ratio,
Price-Earnings Ratio, Price Differentials, and Reverse Engineering
j. Our projected Year +1 EPS based on projected comprehensive income availa-
Chapter 14
Valuation: Market-Based Approaches
14-23
in whole or in part.
k. Using the Year +1 EPS forecast of $5.33 from Solutions j and the $69.09
share price at the end of 2012, Walmart’s price-earnings ratio is 12.96. Thus,
Walmart’s value-earnings ratio of 16.3 is greater than its price-earnings ratio
l. Note: This question requires students to assume a 1% long-run growth rate
(rather than 3% for the other parts). We make this change because with a 3%
risk-free discount rate and a 3% long-run growth rate, the perpetuity value of
earnings in Year + 6 and beyond, when divided by RF – g (0.03 – 0.03 = 0.0),
market has discounted Walmart shares for risk as of the end of 2012.
m. Reverse engineering Walmart’s share price at the end of 2012 to solve for the
implied expected rate of return yields 10.61%, which is considerably greater
makes our value estimate exactly equal the end-of-2012 market price of
$69.09.
n. Reverse engineering Walmart’s share price at the end of 2012 to solve for the
9.0% discount rate implied by the CAPM (computed in Solutions a) is a
reliable proxy for the market’s expected rate of return. We then solve for the
Chapter 14
Valuation: Market-Based Approaches
14-24
in whole or in part.
Integrative Case 14.1: Starbucks
Valuation of Starbucks’ Common Equity Using Market Multiples.
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 use the projected
financial statements from Integrative Case 10.1 and apply the techniques in Chapter 14 to
compute Starbucks’ required rate of return on equity and share value based on the value-
to-book valuation model. We also compare our value-to-book ratio estimate to
Starbucks’s market-to-book ratio at the time of the case to determine an investment
recommendation. In addition, we compute the value-earnings and price-earnings ratios
and the price differential and we reverse engineer Starbucks’ share price as of the end of
2012.
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, and the share price was $50.15.
Part I— Computing Starbucks’ Value-to-Book Ratio Using the Value-to-Book Valua-
tion 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:
The remaining rows of the table include discounting the residual ROCE for Years +1
through +5 to present value, computing continuing value, and computing the value-
to-book ratio. The share value estimate is $63.55, which is identical to the estimate
obtained using the dividends model in Chapter 11, the free cash flows to equity model
Chapter 14
Valuation: Market-Based Approaches
14-25
in whole or in part.
Exhibit 14.C
Value-to-Book Model Valuation for Starbucks
(Integrative Case 14.1)
Continuing
RESIDUAL INCOME VALUATION 1 2 3 4 5 Value
Comprehensive Income Available for Common Shareholders 1,573.5 1,793.3 2,038.3 2,302.8 2,871.4 2,957.6
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
Implied ROCE 30.8% 32.6% 31.8% 32.3% 35.5% 30.0%
Residual ROCE 23.3% 25.1% 24.3% 24.8% 28.0% 22.5%
Cumulative growth factor in common equity as of t–1 100.0% 107.6% 125.4% 139.4% 158.3% 193.0%
Chapter 14
Valuation: Market-Based Approaches
14-26
in whole or in part.
b. and c.
Projected residual ROCE amounts for Starbucks in Years +1 to +6 are presented in
Exhibit 14.C above.
e. The data above indicate that projected residual ROCE in Year +6 will be 43.4%.
Using the 7.50% required rate of return on common equity from Solution a as a dis-
f. We compute Starbucks’ value-to-book ratio as of the end of 2012 with the following
three steps: (1) The total sum of the present value of all future residual ROCE (from
h. Using the value-to-book ratio, we project a $63.55 value per share of common equity
in Starbucks [(9.321 value-to-book ratio × $5,109 million book value)/749.3 million
shares].
Part II—Analyzing Starbucks’ Share Price Using the Value-Earnings Ratio, Price-
Earnings Ratio, Price Differentials, and Reverse Engineering
Starbucks’ value-earnings ratio to be 30.3.
Chapter 14
Valuation: Market-Based Approaches
14-27
in whole or in part.
k. Using the Year +1 earnings-per-share forecast of $2.10 from Solutions j, and using
the $50.15 share price at the end of 2012, Starbucks’ price-earnings ratio is 23.9.
Thus, Starbucks’ value-earnings ratio of 30.3 is greater than its price-earnings ratio,
which suggests that Starbucks’ shares are underpriced in the market. This comparison
market-to-book ratios in Solutions h above.
l. Note: This question requires students to assume a 1% long-run growth rate (rather
than 3% for the other parts). We make this change because with a 3% risk-free dis-
count rate and a 3% long-run growth rate, the perpetuity value of earnings in Year + 6
that the market has discounted Starbucks’ shares for risk as of the end of 2012.
m. Reverse engineering Starbucks’ share price at the end of 2012 to solve for the implied
expected rate of return yields 8.60%. We determine this by assuming that value
$50.15.
n. Reverse engineering Starbucks’ share price at the end of 2012 to solve for the implied
expected long-run growth yields a growth rate of 1.365%. We solve for this growth
rate by assuming that value equals price and that our earnings forecasts through Year
Chapter 14
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14-28
in whole or in part.
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