Question

You are thinking about investing in Starbucks.

In March 2020, the firm paid their 2019 annual dividend of $17.50 per common share. The fiscal year of Starbucks runs April – March.

Due to economic conditions, Wall street and the rest of financial market expect the firm to pay no dividends for next two years. Afterwards, the firm is expected to have fantastic growth for the next 6 years resulting in following (abnormal) dividends for those 6 years: $9.00, $14.00, $23.00, $32.00, $38.00 and $44.00. After that time, the dividend is expected to be $20 in the first year and expected to grow at 4% per year forever. You are thinking of investing in Starbucks.

Your target is to earn 11.5% on your investment, what is the stock worth today, April 1, 2020?

For this problem - today is April 1, 2020. Also, the term “year” used above refers to the firm’s fiscal years that run April – March. Solve using financial calculator and show steps.

Answer 1

The intrinsic value today will be the sum of the future cash flows discounted at the required return of 11.5%

Step 1: Calculate the terminal value at the end of Year 9 = D9*(1+g)/(R - g) where D9 = 20; R = 11.5%; g = 4%

Terminal value (TV) = 20*(1+4%)/(11.5%-4%) = 277.33

Step 2: Cash flow at the end of Year 9 = D9 + TV = 20 + 277.33 = 297.33

Step 3: Enter cash flows in the calculator, as follows:

CF1 = 0; CF2 = 0; CF3 = 9; CF4 = 14; CF5 = 23; CF6 = 32; CF7 = 38; CF8 = 44; CF9 = 277.33 (After every cash flow, you need to press ENTER and then the ↓ button, to take you to the next cash flow entry.)

Step 4: Once cash flows are entered, press NPV button.It will ask for the interest rate. Enter I = 11.5. Press ENTER. Press ↓ button. It will show NPV = . Press CPT button. NPV will be computed.

Intrinsic value of the stock today = 193.33