Starbucks is the company:
In order to understand the risk and return of the company you will estimate risk parameters and the cost of capital for Starbucks.
Most publicly traded corporations are required to submit 10Q and 10K reports to the SEC detailing their financial operations over the previous quarter or year, respectively. Find the most recent 10K and 10Q and download the forms. Look on the Balance Sheet to find the book value of debt and the book value of equity. Find the section that lists a breakdown of company's long-term debt.
1. Cost of Equity
In order to estimate the cost of equity, go to finance.yahoo.com or msn.money.com and find answers to the following questions:
a) What is the most recent stock price?
b) What is the market value of equity, or market capitalization?
c) How many shares of stock does the company have outstanding?
One measure of the risk or volatility of an individual stock is the standard deviation of the total return over several periods of time. Although the standard deviation is easy to compute, it does not take into account the extent to which the price of a given stock varies as a function of a market index, such as the S&P 500. As a result, we use another measure of risk - beta.
Betas for individual stocks are determined by simple liner regression. The dependent variable is the total return for the stock and the independent variable is the total return for the stock market. We will use S&P 500 index as a measure of the total return for the stock market. The beta for the stock is the slope of the estimated regression equation (b1).
1. Run a regression of monthly returns on your firm's stock on monthly returns on a market index, using monthly data and 5 years of observations. What slope of the regression did you estimate and what does it tell you about the riskiness of the stock?
2. Using the beta that you have calculated, estimate the expected return on equity of the company. Go back to finance.yahoo.com and follow the "Bonds" link. What is the yield on 3-month Treasury bills? Using a 7% market risk premium, what is the cost of equity for the company using CAPM?
CAPM: cost of equity r=risk free rate (rf) + β * (rm - rf), where (rm - rf) is market risk premium
3. Go to www.reuters.com and find the list of competitors in the industry. Find the beta for each of these competitors, and then calculate the industry average beta. Using the industry average beta, what is the cost of equity? Does it matter if you use the beta for the company or the beta for the industry?
4. What are the book and market values of equity?
2. Cost of Debt
You now need to estimate default risk and cost of debt.
1) What is the most recent rating for the company?
2) What is the default spread and interest rate associated with this rating?
Go to Morningstar (or another financial website) and locate the information on bonds outstanding for your company. It can be a little tricky to navigate the website, but if you follow this link (I searched for AAPL), you can type in your company's ticker symbol and see its bonds:
Find the yield to maturity for each of the company's bonds. What is the weighted average cost of debt for the company using the book value weights and the market value weights? Does it make the difference if you use the book value weights or market value weights?
3) Weighted Average Cost of Capital - after tax WAAC
a) Calculate WACC for the company using market weights of debt and equity.
b) Do you think that the firm's capital mix is fairly close to optimal or would you suggest any possible changes? Explain your thinking about this.