STARBUCKS VALUATION

An analysts perspective on the past, present and future of

Americas coffee giant.
Prepared by Gavin Virgo
Prepared for Professor Michael Reynolds
ADM 4350 Equity Valuation
8 April 2009
2

Tab|e of Contents
Tab|e of Contents.............................................................................................. z
Executive 5ummary .......................................................................................... q
Note About 5ources ..........................................................................................
Academic Integrity............................................................................................
Introduction ..................................................................................................... 6
Boom and Bust .................................................................................................................................................... 6
Brief Company History....................................................................................................................................... 7
Praise and Criticism............................................................................................................................................. 8
Environment..................................................................................................... j
Global .................................................................................................................................................................... 9
The United States .............................................................................................................................................. 10
Industry ............................................................................................................................................................... 11
Competition ....................................................................................................z
Direct Competition ........................................................................................................................................... 12
McDonalds Corp. ............................................................................................................................................. 12
Peets Coffee & Tea Inc. ................................................................................................................................... 13
Tim Hortons Inc. .............................................................................................................................................. 13
Indirect Competition......................................................................................................................................... 13
Nestle S.A. ...................................................................................................................................................... 13
Yum! Brands Inc. ............................................................................................................................................. 13
Competitive Forces ........................................................................................................................................... 13
Bargaining Power of Suppliers ........................................................................................................................... 14
Bargaining Power of Customers ......................................................................................................................... 14
Threat of New Entrants.................................................................................................................................... 15
Threat of Substitute Products............................................................................................................................. 15
Competitive Rivalry Within an Industry............................................................................................................ 15
Operationa| Risks.............................................................................................6
Strategic Transformation Initiatives ............................................................................................................... 16
Reduced Customer Traffic.................................................................................................................................. 16
Commodity Costs .............................................................................................................................................. 16
Economic Crisis ................................................................................................................................................ 17
Competition....................................................................................................................................................... 17
3
Perceived Brand Value...................................................................................................................................... 17
Ana|ysis...........................................................................................................)
Abso|ute Va|uation: Oiscounted Free Cash F|ow ................................................ 8
Free Cash Flow to the Firm (FCFF) Projections ......................................................................................... 18
Cost of Equity.................................................................................................................................................... 18
Risk-free Rate of Return ................................................................................................................................... 18
Beta .................................................................................................................................................................. 19
Market Risk Premium ..................................................................................................................................... 19
Capital Asset Pricing Model (CAPM) ............................................................................................................. 19
Cost of Debt....................................................................................................................................................... 19
Weighted Average Cost of Capital (WACC) ................................................................................................. 19
Growth Rate....................................................................................................................................................... 19
Valuation Application and Sensitivity Analysis............................................................................................. 20
Implications ........................................................................................................................................................ 20
Re|ative Va|uation............................................................................................zo
Price-To-Earnings (P/E) Multiple Valuation ............................................................................................... 20
Implied Share Price ........................................................................................................................................... 21
Price-To-Book (P/B) Multiple Valuation...................................................................................................... 22
Implied Share Price ........................................................................................................................................... 22
Enterprise Value (EV) Multiple Valuation.................................................................................................... 22
Integrated Ana|ysis ..........................................................................................z
Recommendation ............................................................................................zq
Appendix A: 5tarbucks Historica| Ba|ance 5heet.................................................z
Appendix B: 5tarbucks Historica| Income 5tatement ..........................................z)
Appendix C: 5tarbucks Historica| Cash F|ow 5tatement...................................... zj
Appendix C: Oiscounted Free Cash F|ow to the Firm ~ Oetai|ed Pro|ections...........
Appendix O: Va|uation App|ication....................................................................
4
Executive 5ummary
The Seattle-based Starbucks Corporation (Nasdaq:
SBUX) is the worlds leading roaster and retailer of speciality coffee. There
are more than 16,680 Starbucks stores located around the world, of
which approximately 8,536 are company owned and operated.
After enjoying years of phenomenal growth and high margins, the
company appears to have hit a stumbling block
in the mid 2000s with the simple realization that such high growth is
not sustainable. The stock, which had reached a high of nearly $40 per
share in May 2006, nosedived, touching a low of $7.83 per share in
November 2008. The stock is currently hovering around $11.19 as of April 7, 2009.
After a shake-up in the executive ranks of the company, Starbucks announced
several transformation and restructuring initiatives to slow the
companys growth and trim costs. This included the closing of 600 stores in the United
States, another 61 in Australia, and the elimination of 600 administrative and support
positions.
In addition, the company is facing significant competitive threats from major
U.S quick-service restaurants, the most apparent being McDonalds. It is expected that
competition from McDonalds, which has recently announced plans to open cafes within
their existing restaurants, will increase pressure on profit margins and reduced Starbucks
market share in the future.
In the following analyst report, a number of methodologies have been applied to assess the
value of Starbucks current share price and make a sound recommendation to investors.
Together, these methodologies support the conclusion that Starbucks shares are
presently relatively undervalued. A weighted blend of absolute and relative
valuation methods implies that the intrinsic value of the stock is
approximately $14.24 per share. This represents are 27 per cent
premium over the April 7, 2009 close price of $11.19.
It is likely that the share price will converge to this intrinsic value in the long-term. Given
that the target price represents a substantial premium over the current price of the stock,
Starbucks has been assigned a buy recommendation.
Target:
$14.24
Recommendation:
BUY
5
Note About 5ources
Please note that this document refers to information from many sources. Where direct or
indirect references have been made, they are carefully documented in the footnotes found at
the bottom of each page. In some instances I have referred to the source directly within the
text. All financial information within this document and used in the analysis was obtained
through Starbucks financial statements, Yahoo! Finance, Mergent Online or Research
Insight. Yahoo! Finance is a public data repository, which can be accessed at
http://finance.yahoo.com. Mergent Online is a subscription-based database, which is
available to students at the University of Ottawa. Research Insight is a subscription-based
software that uses Standard & Poors COMPUSTAT database, and is also available to
students at the University of Ottawa.
Academic Integrity
This assignment conforms to the rules and regulations on academic integrity at the
University of Ottawa.
6
Introduction
The Seattle-based Starbucks Corporation (Nasdaq: SBUX), formed in 1985, is the worlds
leading roaster and retailer of specialty coffee.
1
There are more than 16,680 stores operating
under the Starbucks banner in regions all over the world, including the Americas, Europe,
Middle East, Africa and the Asia Pacific. Of these, approximately 8,536 stores are company-
owned and are disproportionately located in the United States.
The companys self-stated business description, according to the 2009 annual report is as
follows:
Starbucks purchases and roasts high-quality whole bean coffees and sells them,
along with fresh, rich-brewed coffees, Italian-style espresso beverages, cold blended
beverages, a variety of complementary food items, a selection of premium teas, and
coffee-related accessories and equipment, primarily through Company-operated retail
stores.
2

Boom and Bust
Notwithstanding the financial environment that is wreaking havoc on U.S. markets and the
global economy, Starbucks is in the midst of a crisis of its own. Having reached a high of
nearly $40 per share in May 2006, the stock has since plummeted falling as low as $7.83 in
November of 2008.
While much of this can be attributed to the U.S. economic meltdown and deteriorating
business conditions, Starbucks is also in the midst of a great transformational challenge.
Once thought to be a hot growth stock, expectations have plunged as analysts, investors,
and management have come to realize that some markets have become super-saturated with
Starbucks stores.
3
There has been a revelation in the investment community and awakening
to the fact that there is a limit to the demand for coffee, espresso, lattes, and Frappucinos
which was once thought to be insatiable.
4
In addition, Starbucks is now facing major
competitive threats from much bigger rivals seeking to enter the lucrative gourmet coffee
market.
As a result, the beleaguered company has responded with a number of changes and
transformational initiatives. In January 2008, Starbucks announced a surprise change in
leadership as Chairman and company founder Howard Schultz fired Chief Executive Officer
Jim Donald and took on that role himself. Schultz announced a back-to-the-basics long-

1
Starbucks 2009 Annual Report
2
Starbucks 2009 Annual Report
3
Karen Blumenthal, Grande Expectations: A Year in the Life of Starbucks Stock, Crown Business: New York, 2007, p. 12
4
Frapuccino is a Starbucks trademark, referring to a line-up of cold-blended coffee-based beverages.
7
term approach for the company that would deliberate slow the companys growth and
attempt to rekindle customers emotional attachment to Starbucks.
5

While it is too early to see whether this gamble will pay off, it is clear that many investors
have opted not to stick around and find out. Given the high degree of uncertainty
surrounding the company and the stated long-term approach to building shareholder value,
is it possible that Starbucks has become an investment opportunity for value investors?
This is the very question that this report sets out to address. By attempting to identify the
intrinsic value of the Starbucks Corporation and comparing this value to the current share
price, it is possible to determine whether this security represents a valuable opportunity for
investors.
Brief Company History
Starbucks has an epic and storied history, which has been documented extensively in
company literature, on the Internet and in many books that have been written about the
company. Reborn into its modern, more recognizable form in 1985, the first Starbucks was
located in the heart of the Pikes Place fish market in Seattle in 1971. Founded by three
partners, the company sold dark-roasted, high-quality whole bean Arabica coffee. The store,
which did not sell prepared coffee beverages, was moderately successful and popular among
locals.
In 1982, Starbucks current Chairman and Chief Executive Officer, Howard Schultz, joined
the company. Working in the capacity of Director of Retail Operations and Marketing,
Schultz travelled to Italy in 1983 where he witnessed the romance of Italian espresso, and
became determined to bring this experience to Starbucks.
6

However, the three original Starbucks partners stood in Schultz way and resisted to the
changes that he proposed: namely, that Starbucks begin selling prepared coffee and espresso
beverages in-store. Then, with the support of Starbucks, Schultz began his own company
called Il Giornale to test his idea. Il Giornale offered customers prepared coffee beverages
made from Starbucks own beans, and was an instant success. Looking to expand his new
company, Schultz acquired Starbucks and its assets in 1987 and changed the companys
name to Starbucks Corporation. In 1991, Starbucks completed an initial public offering
(IPO) and began trading on the Nasdaq under the symbol SBUX.
Over the years, Starbucks continued to expand at a supersonic growth rate, both in the U.S.
and abroad. The company and its stock, by extension, continuously outperformed the

5
In a jolt, Starbucks fires CEO, replaces him with Schultz, Seattlepi.com. Retrieved from
http://www.seattlepi.com/business/346397_sbuxdonald08.html on 7 April 2009.
6
Howard Schultz, Pour Your Heart Into It, Hyperion: New York, 1997, p. 56
8
market and surpassed the expectations of analysts and investors. In 2005 the stock was so
hot that it was widely regarded as a must-have for fund managers and often used to
window-dress portfolios.
7

Shortly after this, however, the Starbucks engine began to sputter. The first indication came
in the form of declining comps referring to comparable same-store sales a key
organizational health indicator for analysts. This was regarded as a sign that Starbucks was
approaching (if it had not already reached) the peak of its growth, which was previously
thought to be limitless.
In January 2008, Howard Schultz, the company founder and chairman, returned to the role
of CEO after an eight-year hiatus, announcing a renewed focus on building brand loyalty
and rekindling the emotional attachment with customers.
8
Nearly simultaneously, Schultz
announced plans to close more than 600 underperforming U.S. company-operated retail
stores and 61 more stores in Australia.
9
Soon after, the company announced plans to
eliminate more than 600 administrative and support non-store positions in an effort to
trim costs.
10
In fiscal 2008 and first quarter 2009, Starbucks reported $342.4 million in
restructuring costs related to these measures resulting in a substantial decline in year-over-
year earnings.
Praise and Criticism
Over the many years of operations, Starbucks has received its share of praise and criticism.
The company has strived to build a reputation for caring for employees and community
involvement. Some initiatives to this effect include:
granting health benefits to full and part-time staff;
offering employee stock option and purchase programs to full and part-time staff;
promoting child and adult literacy through numerous book drives and the Starbucks
Foundation, which supports local literacy programs;
forming Urban Coffee Opportunities, a joint-venture with celebrity Earvin Magic
Johnson to introduce the Starbucks brand to underdeveloped urban and suburban
communities;
introducing coffee sourcing guidelines and committing to make some purchases of fair
trade coffee.

7
Window-dressing refers to a strategy used by portfolio managers to enhance the appearance of performance. Fund managers purchase the
hottest and best performing stocks to literally dress-up their portfolios (especially toward the end of a reporting period), so that it
appears that they were insightful enough to purchase these high-performing securities.
8
In a jolt, Starbucks fires CEO, replaces him with Schultz, Seattlepi.com. Retrieved from
http://www.seattlepi.com/business/346397_sbuxdonald08.html on 7 April 2009.
9
Starbucks Coffee Company, Announcement to Customers. Retrieved from http://www.starbucks.com/australia/ on 7 April 2009
10
Starbucks turns to customer ideas, BBC News. Retrieved from http://news.bbc.co.uk/2/hi/business/7338448.stm on 7 April 2009
9
However, on the other side of the coin, the company is a popular target for criticism and has
been denounced for its labour practices and alleged unethical conduct with regard to its
purchasing practices and supply chaining. Criticism related to labour practices is often made
with respect to the fact that the company is decidedly anti-union, and has engaged in
mischievous, and at times illegal, behaviour in order to discourage or stomp out employees
efforts to form unions. Starbucks has been accused of the mistreatment and exploitation of
coffee farmers, who are overwhelmingly representative of the poorest parts of the world.
While the company has committed to purchasing some fair-trade certified coffee, this
amount represents a tiny fraction of Starbucks total coffee purchases. In addition, the
company and its representatives have, at times, publically lambasted the fair trade model of
business, asserting that this business model distorts incentives for farmers and results in the
purchase of poor quality coffee beans.
Environment
G|oba|
As of the end of the first quarter of 2009, the outlook for the global economy is bleak.
According to the IMF, world growth is expected to fall to just 0.5 per cent, the lowest rate
seen since the Second World War.
11
Increasingly, the effects of the U.S.-born subprime
meltdown and credit crisis are being felt around the globe, hammering both advanced and
emerging economies. In 2009, output in advanced economies is expected to contract by 2
per cent, while growth in emerging economies will slow sharply from 6 per cent in 2008
to 3 per cent in 2009.
12

In addition, the IMF notes, the current economic environment has produced dampened
inflation pressures and some advanced economies are expected to experience a period of
very low (or even negative) consumer prices increases.
13
Financial markets are in freefall
around the world, and virtually all industrialized nations are pursuing fiscal and monetary
stimulus packages in order to curb this sharp and painful recession.
Furthermore, the financial crisis has created a pernicious feedback loop between the
financial and real economy.
14
Uncertainty and fear in the face of reduced wealth and asset

11
January 28, 2009 World Economic Outlook Update, International Monetary Fund. Retrieved from
http://www.imf.org/external/pubs/ft/weo/2009/update/01/ on 7 April 2009
12
Ibid.
13
Ibid.
14
Ibid.
10
values has prompted households and businesses to postpone expenditures, reducing
demand for consumer and capital goods.
15

The IMF notes that the most recent World Economic Outlook Update is characterized by
an unusually large amount of uncertainty.
16
It is clear that Strong and complementary
policy efforts are needed, which should lead to a gradual recovery beginning in 2010.
17

The United 5tates
The United States, which has lead the economic collapse among more advanced economies,
continues to bear the brunt of the financial crisis. All indicators imply that the economy
continues to be battered, despite the efforts of the administration of a new Democratic
president: Barack Obama. According to a March 2009 Country Report, authored by the
Economist Intelligence Unit, GDP growth contracted by 6.2 per cent in the fourth quarter
of 2008 and Indicators have remained poor in recent months, suggesting that the
contraction will continue.
18

It is expected that president Obama, who was warmly welcomed to the White House in
January, will generally seek to co-operate more with allies opting for more multi-lateral
solutions as opposed to the solo approach preferred by the previous administration.
19
The
new administration will primarily focus on containing the financial and economic crisis,
beginning with a $787 billion stimulus package that was signed into law in February.
20

A financial rescue package put forward by the Obama administration received a cold
response from financial markets and it appears that some major financial institutions will
have to be nationalized in the coming months.
21
There are indeed some signs of increased
stabilization in the financial system, although this is primarily a result of policy measures and
financial conditions remain very tight.
22

Current US stock market performance is characterized by extreme volatility. Every key index
has lost value since the beginning of the year. As of March 31, the Dow Jones Industrial
Average has retreated nearly 16 per cent in 2009. The S&P 500 index and Nasdaq
Composite index have shaved 14 per cent and 6 per cent of their respective values. Market
performance is illustrated in Figure 1, below.

15
Ibid.
16
Ibid.
17
Ibid.
18
March 2009 Country Report: United State of America, The Economist Intelligence Unit.
19
Ibid.
20
Ibid.
21
Ibid.
22
Ibid.
11

Figure 1 - Performance of Broad U.S. Market Indices, First Quarter 2009
Optimism seems to be fading among investors who have so far remained largely
unresponsive to the economic stimulus package and efforts of the Obama administration.
This seeming lack of confidence is reflected in the fact that a disproportionate number of
U.S. stocks are trading below their 200-day moving average, a key technical indicator for
investors. It is now clear that U.S. markets have not yet reached the trough and the question
investors are asking is just how far can they fall?
Industry
The food-service industry has been especially hard hit by the ongoing severe global
recession. The performance of restaurants and specialty eateries, like Starbucks, are heavily
dependent on consumer discretionary spending. Consumers, who are growing concerned
about the safety of their jobs and retirement savings, are spending significantly less and it is
showing up in the form of reduced revenues.
In the coffee-retailing industry, Starbucks is facing increased competitive pressures. Major
fast-food retailers and other quick-service restaurants have awakened to the high demand
for, and lucrative margins from sales of gourmet coffee.
Coffee costs have remained relatively stable in recent times (shown in Figure 2) and have not
had a substantial price impact on coffee-retailers and quick-service restaurants in 2008.
63
70
73
80
83
90
93
100
01/02/09 03/31/09
U.S. Market Index erformance
I|rst uarter 2009
uow !ones lndusLrlal
Average
S& 300
nasdaq ComposlLe
12

Figure 2 Average Monthly Coffee Prices based on the International Coffee Organization Composite, U.S. Cents
per Pound
Competition
Starbucks faces stiff competition that has only been heating up even further in recent times.
In the past, the company has made attempts to differentiate and stand out, which can make
comparison difficult. Starbucks competition consists of both direct and indirect
competition.
Oirect Competition
Starbucks competed directly against competitors that offer similar product offerings
namely, prepared coffee beverages.
McOona|ds Corp.
McDonalds Corp. (NYSE: MCD) represents the number one threat to Starbucks at this
point in time. The globally recognized fast-food heavyweight has recently announced its
foray into the specialty coffee segment, and its intention to take Starbucks on headfirst. In
what is being characterized as the American latte wars, McDonalds is rapidly adding coffee
capabilities to select locations of its more than 30,000 restaurants around the world, and
attempting to mimic the Starbucks model.
23

McDonalds is a highly successful organization with resources that cannot be matched by
Starbucks. There is no question that a successful entry into this market would significantly
eat away at Starbucks profits and margins.

23
The Latte Wars, Newsweek. Retrieved from http://www.newsweek.com/id/91497 on 7 April 2009

C
o

e
e

r
|
c
e
s
,

U
.
S
.

C
e
n
t
s

p
e
r

o
u
n
d

ICC Compos|te r|ce, Month|y
Average
13
Peet's Coffee 8 Tea Inc.
Peets Coffee and Tea (NASDAQ: PEET) is a coffee roaster and market of coffee with a
moderate presence in the mid-West and West United States. The company sells coffee, tea,
brewing equipment, mugs and accessories through many channels including company
operated retail stores, grocery stores and foodservice accounts. As of the end of 2008, Peets
had 188 retail stores and reported revenues of $284.8 M.
Tim Hortons Inc.
Tim Hortons Inc. (NYSE: THI) is engaged in the development and franchising of quick-
service restaurants that serve food such as hot and cold coffee, baked goods, sandwiches and
soups. The company has a significant presence in Canada, with more than 2,800 stores, and
approximately 400 more located in the U.S. While the company does not focus on gourmet
coffees and espresso sought by coffee aficionados, it nonetheless remains and important
competitor to Starbucks. Tim Hortons revenue in 2008 was in excess of $2.04 billion.
Indirect Competition
Nest|e 5.A.
Nestle S.A. (SIX: NESN) is a Switzerland based holding company with 2007 revenues of
more than $107.6 billion. Nestle is primarily engaged in food processing. The company
produces Nescafe coffee, which is sold at grocery stores all over the world. This company
competes indirectly with Starbucks since it offers coffee through a different distribution
channel, but is an important competitor, nonetheless.
Yum! Brands Inc.
Yum! Brands (NYSE: YUM) is a quick-service restaurant company that operates and
franchises companies such as KFC, Pizza Hut, Taco Bell, Long John Silvers, and A&W All-
American Food Restaurants. Although the company does not compete in the gourmet
coffee business, it competed with Starbucks and others for a portion of consumers
discretionary spending. Yum Brands reported 2008 revenues of $11.3 billion.
Competitive Forces
While it useful to have an understanding of the competitive environment that Starbucks
currency faces, it is important to recognize that the competitive landscape is dynamic, rather
than static, and constantly changing. Thus, it would be prudent to identify trends and
possible outcomes in this environment. Porters Five Forces Analysis model is applied below
to provide insight to this environment:
14
Bargaining Power of 5upp|iers
Starbucks purchases high quality Arabica coffee from coffee growing regions throughout the
world, with the majority of supply coming from Latin America, Africa and the Asia/Pacific
regions. However unfortunate, the traditional and basic nature of the work often entails
farmers working in poverty conditions or at subsistence wages. Thus, historically, coffee
farmers have not been able to exercise a great deal of bargaining power in negotiations with
Starbucks.
Rising awareness of the plight of coffee farmers in the last decade has resulted in the
increasing popularity of social movements encouraging ethical purchasing and consumption
of coffee. At times, Starbucks has been targeted and criticized for its alleged exploitation of
coffee farmers and unethical purchase practices. The company has taken some steps to
address this including a attempting to develop and implement ethical coffee purchasing
guidelines and sustainability plans. However, these efforts have been unexceptional and will
do little to appease Starbucks harshest critics.
Looking down the road, it is likely that supplier bargaining power will continue to increase
marginally in the future as social movements continue to attract the attention of consumers,
and coffee farmers become more advanced and able to collaborate. However, it is unlikely
that this bargaining power will be significant enough to have a material impact on Starbucks
cost of goods.
Bargaining Power of Customers
Historically, Starbucks marketing machine has been highly successful at attracting and
retaining customers with the promise of a high-quality product and customer service
experience. In addition, the company has resorted to efforts such as promotion of gift cards
in order to win the loyalty of consumers. However, the company must continue to innovate
in this area in order to retain the loyalty of increasingly fickle consumers. Today, consumers
have an increasing number of options when it comes to their morning coffee namely, the
aforementioned competitors. Consumers are especially sensitive to price and will likely take
their business where they can get the most value for money. The recessionary pressures of
the current financial environment will only serve to exacerbate this.
In the retail environment, buyer power is high and will only continue to increase as the
competition heats up. Looking foreword, this represents a moderate threat and will likely put
downward pressure on Starbucks margins as customers demand lower prices or threaten to
switch to a competitor.
15
Threat of New Entrants
The barriers to entry in the coffee-retailing business are relatively low. As a commodity,
coffee is typically purchased on a per pound basis meaning that Starbucks cannot benefit
significantly from economies of scale. Furthermore, while the company does possess a
number of patented products and trade secrets, it is not in possession of significant
proprietary technologies that cannot be easily duplicated.
Starbucks uses commercially available equipment such as coffee brewers, espresso machines,
blenders, etc. which can be easily acquired by any competing operation. Indeed, many major
competitors and smaller chains have thrived by adopting or mimicking Starbucks strategy.
In the long-term, the threat of new entrants represents a possible and probable risk to
Starbucks. Rivals, attracted by the high margins that Starbucks has historically obtained, are
quickly moving into coffee retailing and putting downward pressure on Starbucks margins.
Threat of 5ubstitute Products
As a retailer of a product derived from a commodity, there is little that Starbucks can do to
differentiate its physical product. The physical properties of the product are largely derived
from the quality of the ingredients used and how they are processed only some of which
are under Starbucks own control. The quality of coffee, for instance, may depend on the
growing, harvesting, processing, roasting and brewing stages. Here, only roasting and
brewing are directly under Starbucks control. Coffee growing, harvesting, and processing
stages are carried out by the individual farmers.
Consequently, Starbucks has attempted to differentiate its products on the basis of customer
service and the in-store experience, which has often been characterized as the Starbucks
Experience.
24

The threat of substitute products from competitors and other retailers poses a serious threat
to Starbucks future revenue and profitability.
Competitive Riva|ry Within an Industry
As a purveyor of a commodity-based product, Starbucks does not benefit from product
differences that typically influence competitive rivalry. This is especially true given the
increasingly popularity and availability of premium coffees, which has been Starbucks
basis for differentiating itself in the past. While the company has previously benefitted from
a very strong brand identity, there is some evidence suggesting that brand loyalty is eroding.

24
The essence of the Starbucks Experience is outlined in a book of the same name.
16
Competitor rivalry represents a serious threat for Starbucks. As more competitors attempt to
capitalize on the growing demand for gourmet coffee and lucrative profit margins,
Starbucks own market share and margins are likely to be diminished.
Operationa| Risks
Starbucks is subject to a number of operational risks that may have an adverse impact on the
companys performance if they were to materialize. A detailed list of conceivable risks facing
the company is discussed at length in the Starbucks annual report. Some of the most
important and most probable risks are outlined and discussed briefly below.
5trategic Transformation Initiatives
When Howard Schultz returned as the Starbucks CEO in 2008, the company soon after
announced a number of strategic transformational initiatives to bring the company back to
the basics and build long-term shareholder value. This included, but was not limited to, a
plan to close 600 underperforming stores in the U.S. market and a corporate-level
restructuring that would eliminate about 700 non-store jobs. The company also spent
considerable resources developing and implementing a new special coffee Pikes Place
Roast and revised brewing methods and standards for stores around the world. This was
intended to represent the beginning of a renewed focus on coffee that management hopes
will translate to higher sales and loyalty.
These, and other, changes that the company is pursuing come with a myriad of risks. For
instance, the company may not realize the expected cost savings from the restructuring
efforts in the desired time frame, or perhaps at all. Management expects that investments in
the business and development of new offerings like Pikes Place Roast will yield a stream of
future benefits for the company. It is possible that these benefits have been overstated or
that these efforts will not be enough to reinvigorate the brand.
Reduced Customer Traffic
Starbucks may suffer from reduced customer traffic to the increased presence of
competitors, the declining demand of gourmet coffee, or negative publicity regarding the
company. Any of these factors, none of which can be predicted with certainty, would have
an adverse affect on Starbucks business performance.
Commodity Costs
Starbucks purchases large amounts of green coffee and dairy products, which are often
subject to wide price fluctuations.
25
Although risk exposure to volatile coffee prices can be

25
Green coffee refers to the coffee beans that Starbucks purchases from its suppliers in its raw green state, before it is roasted.
17
effectively hedged, it is much more difficult to hedge against commodities such as fluid milk.
Thus, Starbucks is exposed to volatility in dairy prices.
Economic Crisis
A severe global recession is currently in progress. As a retailer that is dependent on
consumer discretionary spending, Starbucks business is likely to suffer in the near future
since consumers will have less discretionary income available. Management expects that this
will negatively impact the Companys financial performance, though it is difficult to
estimate the extent.
Competition
As noted previously, Starbucks is presently facing a serious competitive threat from
McDonalds a fast-food giant with a strong global presence. McDonalds has comparatively
more resources and quick-service experience than Starbucks. Even a semi-successful foray
into gourmet coffee would have significant adverse effects for Starbucks.
Perceived Brand Va|ue
The Starbucks brand is highly valued and it is necessary for the company to maintain this
perception of brand value going forward in order to take on emerging competitive threats.
As a result, incidents or scandals that erode consumer trust or perceived brand-value of
Starbucks would be disastrous for the company.
Ana|ysis
Considering the current economic turmoil and unique transformational circumstances
specific to Starbucks, placing a valuation on this company is a challenging and complex task.
In the following section, multiple methods have been applied for the purpose of determining
the intrinsic value of Starbucks including:
an analysis of the discounted free cash flow to the firm;
an examination of relevant valuation comparables;
a review of performance metrics and organizational health indicators.
Given the enormity of the task at hand, in some instances, it is necessary to make certain
assumptions. These assumptions are based on the views of company management, analysts,
or are otherwise backed up by supporting material. In instances where assumptions have
been made, they are carefully identified and justified.
18
Abso|ute Va|uation: Oiscounted Free Cash F|ow
As a non-dividend paying company, the only suitable absolute model to use in the valuation
of Starbucks is a discounted free cash flow model. Since Starbucks has had relatively volatile
earnings and cash flow in the recent past, a model analyzing the free cash flow to the firm
(FCFF) is the best choice for valuation.
Free Cash F|ow to the Firm (FCFF) Pro|ections
A summary of Starbucks FCFF calculations, five years forward, is presented in the table
below:
Table 1 - 5-Year FCFF Projections for Starbucks Corp.
2008 A 2009 E 2010 E 2011 E 2012 E 2013 E
EBI T( 1- T) 535, 423 214, 708 214, 708 225, 443 236, 715 248, 551
+ Dep 549, 300 518, 682 504, 401 534, 291 576, 418 621, 627
- FCI nv 626, 029 - 419, 224 - 145, 871 305, 316 430, 305 461, 790
- WCI nv 31, 517 26, 848 36, 731 49, 357 65, 407 85, 716
FCFF = 427, 177 1, 125, 765 828, 249 405, 061 317, 422 322, 672

A close look at Table 1 reveals that EBIT is expected to continue to decline through 2010 as
Starbucks faces increased competition and the effects of the global recession. Depreciation
will continue to increase at a steady rate as the company continues to invest in fixed assets,
which, in turn are a function of sales revenue.
Note that capital expenditure, as a percentage of sales, will continue to decrease in the future
as the company deliberately attempts to slow the growth of company-operated retail stores,
in accordance with its transformational strategy (previously discussed.)
Full details on the Starbucks FCFF calculation can be found in Appendix A.
Cost of Equity
Risk-free Rate of Return
As a U.S. based public corporation, the relevant risk-free rate of return is that of short-term
(3-month) U.S. Treasury bills.
19
As of April 2009, that rate is 0.2%, annually.
26

Beta
Starbucks beta is 0.93, indicating a relatively strong covariance with broad market indices.
Market Risk Premium
The market risk premium applied to the valuation is 6.5 per cent. This risk premium is based
on an academic survey of more than 1000 professors in 2008.
27

Capita| Asset Pricing Mode| (CAPM)
Based on the above-listed inputs, a simple application of CAPM reveals that Starbucks cost
of equity is approximately 8.05 per cent.
Cost of Oebt
Starbucks Corp. has historically had a very clean balance sheet. In 2007 the company issued
$550 million in senior notes at 6.25 per cent. The notes are due on August 15, 2017. Once
the tax shield provided by the tax deductibility of interest is taken into account, the after tax
cost of debt is approximately 4.26 per cent.
Weighted Average Cost of Capita| (WACC)
Starbucks long-term debt to total capital ratio is approximately 18.08 per cent. The company
has not announced any plans to change the capital structure in the foreseeable future, so it is
assumed that this will remain constant. Based on this assumption, Starbucks WACC is
approximately 7.36 per cent.
Growth Rate
The estimated FCFF growth rate is a key determinant of the intrinsic value in a discounted
cash flow analysis due to the important of the terminal value. It is difficult to estimate this
growth rate in such a turbulent environment, and therefore, it would be prudent to be
mindful of the valuations sensitivity to this estimate.
Consequently, a table has been prepared below using a range of growth rates with 4 per cent
identified as the most likely outcome.

26
Note that this rate is relatively low by historical standards. The financial and economic crisis has resulted in a flight to safety in the form
of U.S. government bonds.
27
Pablo Fernandez, Market Risk Premium Used in 2008: A Survey of More than a 1,000 Professors. Retrieved from
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1344209 on 7 April 2009.
20

Va|uation App|ication and 5ensitivity Ana|ysis
Table 2 - Discounted Free Cash Flow to the Firm Valuation and Sensitivity Analysis for Starbucks Corp
Gr owt h Rat e
3% . 4% 5%
Fir m Value 7, 904, 048 9, 561, 959 12, 624, 868
Equit y Value 7, 354, 448 9, 012, 359 12, 075, 268
I mplied Shar e Value
Basic $10. 05 $12. 32 $16. 51
Dilut ed $9. 92 $12. 15 $16. 28

Imp|ications
The above table indicates a range of possible intrinsic values for Starbucks stock, given
various growth assumptions. A close look at the table reveals that the implied share price is
indeed quite sensitive to the growth rate. At a four per cent free cash flow growth rate, the
estimated intrinsic value of the share price is $12.15.
As of April 7, 2009, Starbucks ended the trading day at $11.19. Therefore, the stock is only
slightly relatively undervalued in comparison to the estimate. This amount is so marginal that
we would consider the stock to be priced near perfectly.
Re|ative Va|uation
Methods of absolute valuation can and should be supplemented by relative valuation
techniques. By analyzing comparables and multiples, it is possible to refine and develop
support for the conclusions using absolute valuation methods.
Price-To-Earnings (PjE) Mu|tip|e Va|uation
A table illustrating the trailing and forward P/E ratios for Starbucks and select competitors
is shown below in Table 3.
21

Table 3 - Forward and Trailing P/E Ratios for Starbucks Corp. and Select Competitors
Company Tr ai l i ng P/ E
28

For w ar d
P/ E
29

McDonalds 14. 72 13. 29
Nest le - -
Peet ' s Coffee and Tea 26. 94 19. 91
St ar bucks 48. 23 13. 32
Tim Hor t ons 20. 91 15. 39
Yum! Br ands 14. 66 12. 46
Compet i t or Av er age 25. 092 14. 874

An analysis of the above table reveals that Starbucks has a comparatively high P/E ratio than
that of all competitors and the industry average. Starbucks, which has a trailing P/E ratio of
48.23, could be relatively overvalued as investors have paid more for each dollar of earnings.
One possible reason for this has been the poor and volatile performance of the company,
especially in the last twelve months. In 2008, profit dropped more than 53 per cent as the
company incurred more than $266.9 million in restructuring costs. Note, however, that other
competitors (also competing for consumer discretionary spending) faced the same
deteriorating economic conditions meaning that these effects should be factored into their
P/E ratios.
For these reasons, it may be prudent to refer to the forward P/E multiple when conducting
a relative valuation. Comparing Starbucks forward P/E multiple to those of its competitors
reveals that Starbucks is relatively on part with its competitors with a forward P/E ratio of
13.32.
Imp|ied 5hare Price
Based on the industry average trailing P/E of 25.092, the implied share price of Starbucks is
$23.34.
30
However, adjusting for the fact that Starbucks own exceptionally high trailing P/E

28
Trailing, 12 months moving
29
Forward, fiscal year-end 2010
30
Based on reported 2008 EPS of 0.93 (basic and diluted)
22
ratio has undue influence on the industry average, the share price estimate declines to
$17.96.
31

Price-To-Book (PjB) Mu|tip|e Va|uation
A table illustrating the price-to-book ratios for Starbucks and select competitors is shown
below in Table 4. Note that Yum! Brands has been excluded from this calculation since it
has an exceptional P/B ratio of -127, reflecting the unique conditions of that company.
Table 4 - Price-to-book Ratios for Starbucks Corp. and Select Competitors
Company Pr i ce- t o- book
McDonalds 4. 62
Nest le -
Peet ' s Coffee and Tea 1. 97
St ar bucks 3. 2
Tim Hor t ons 5. 16
Yum! Br ands -
Compet i t or Av er age 3. 738

An analysis of the table above reveals that Starbucks may be relatively undervalued when
compared to it two largest competitors and the competitor average.
Imp|ied 5hare Price
Using the competitor average P/B ratio, the estimated value of a Starbucks share is $10.99
(basic) and $10.88 (diluted.)
Enterprise Va|ue (EV) Mu|tip|e Va|uation
A table illustrating the EV/EBITDA ratios for Starbucks and select competitors is shown
below in Table 5.

31
Industry average trailing P/E multiple is 19.31 when Starbucks is excluded
23

Table 5 - EV/EBITDA Ratios for Starbucks Corp. and Select Competitors
Company EV/ EBI TDA
McDonalds 9. 00
Nest le -
Peet ' s Coffee and Tea 8. 76
St ar bucks 8. 18
Tim Hor t ons 9. 21
Yum! Br ands 8. 22
Compet i t or Av er age 8. 67

An analysis of the table above reveals that Starbucks is approximately in line with
EV/EBITDA ratios of other firms in its industry. Starbucks EV/EBITDA is slightly lower
than the competitor average indicating that the firm may be slightly undervalued based on its
EBITDA.
Integrated Ana|ysis
The various conclusions reached using absolute and relative valuation methods can be
blended to reach a single target price for the stock and the basis for a recommendation.
Below, in Table 6, conclusions from prior analysis are blended to reach a single share price.
Table 6 - Blended Target Share Price for Starbucks Corp.
Anal y si s Met hod Di scount ed Fr ee Cash
Fl ow t o t he Fi r m
P/ E I mpl i ed Shar e
Pr i ce
P/ B I mpl i ed Shar e
Pr i ce
Est imat ed I nt r insic
Value
$12. 32 $23. 34 $10. 88
Weight Given t o
Met hod
60% 40% 40%
Bl ended Tar get Pr i ce = $14. 24
24
Based on the blended analysis, using the estimated share prices and weights shown above,
the target price for shares of Starbucks Corp. is $14.24. This represents a 27 per cent
premium over the April 7, 2009 close price of $11.19.
Recommendation
STRONG BUY
BUY
HOLD
SELL
$14.24
STRONG SELL

A through analysis of Starbucks Corp. indicates that the stock is currently undervalued at
11.19 (close price as of April 7, 2009.) It is probable that the stock price is currently being
battered by economic uncertainty and investor risk-aversion to the potential for further
losses in the stock market. Also, the current stock price may be an overreaction to
disappointing results in the first quarter of 2009.
However, these results have been taken into consideration in the discounted cash flow
analysis accompanied by very modest growth expectations for the future. It should also be
noted that while recent financial results have been somewhat concerning, the company is
taking strides to address this through a number of restructuring and transformation
initiatives.
As the company faces increasing competition in the future, Starbucks will likely experience
reduced sales and earning growth, with margins lower than the company has typically
achieved in the past. However, this is the new reality for this company. No longer a hot
growth stock, Starbucks is making a rapid transition into its mature phase. Investors have
penalized the company heavily during this transition, making it a valuable investment
opportunity.
25
Appendix A: 5tarbucks Historica| Ba|ance 5heet
Starbucks Corp.

As Reported Annual Balance Sheet 10/03/2004 10/02/2005 10/01/2006 09/30/2007 09/28/2008
Currency USD USD USD USD USD
Auditor Status
Not
Qualified
Not
Qualified
Not
Qualified
Not
Qualified
Not
Qualified
Consolidated No No No No No
Scale Thousands Thousands Thousands Thousands Thousands

Operating funds & interest bearing
deposits 219,809 62,221 84,943 - -
Money market funds 79,319 111,588 227,663 - -
Cash & cash equivalents 299,128 173,809 312,606 281,261 269,800
Short-term investments - available-for-sale
securities 329,082 95,379 87,542 83,845 3,000
Short-term investments - trading securities 24,799 37,848 53,496 73,588 49,500
Accounts receivable, gross 142,457 193,841 228,098 291,125 334,000
Less: allowance for doubtful accounts 2,231 3,079 3,827 3,200 4,500
Accounts receivable, net 140,226 190,762 224,271 287,925 329,500
Unroasted coffee 233,903 319,745 328,051 339,434 377,700
Roasted coffee 46,070 56,231 80,199 88,615 89,600
Other merchandise held for sale 81,565 109,094 146,345 175,489 120,600
Packaging & other supplies 61,125 61,229 81,627 88,120 104,900
Inventories 422,663 546,299 636,222 691,658 692,800
Prepaid expenses & other current assets 71,347 94,429 126,874 148,757 169,200
Deferred income taxes, net 81,240 70,808 88,777 129,453 234,200
Total current assets 1,368,485 1,209,334 1,529,788 1,696,487 1,748,000
Long-term investments - available-for-sale
securities 135,179 60,475 5,811 21,022 71,400
Equity method investments 152,511 189,735 205,004 234,468 267,900
Cost method investments 16,430 8,920 11,283 24,378 34,700
Other investments 2,806 2,806 2,806 - -
Equity & other investments 171,747 201,461 219,093 258,846 -
Equity & cost investments - - - - 302,600
Land 13,118 13,833 32,350 56,238 59,100
Buildings 66,468 68,180 109,129 161,730 217,700
Leasehold improvements 1,497,941 1,947,963 2,436,503 3,103,121 3,363,100
Store equipment - 646,792 784,444 1,002,289 1,045,300
Roasting equipment - 168,934 197,004 208,816 220,700
Roasting & store equipment 683,747 - - - -
Furniture, fixtures & other property, plant &
equipment 415,307 476,372 523,275 559,077 517,800
Work in progress - - - - 293,600
Property, plant & equipment, at cost 2,676,581 3,322,074 4,082,705 5,091,271 5,717,300
Less: accumulated depreciation &
amortization 1,298,270 1,625,564 1,969,804 2,416,142 2,760,900
Property, plant & equipment before work-
in-progress 1,378,311 1,696,510 2,112,901 2,675,129 -
Work in progress 93,135 145,509 174,998 215,304 -
Property, plant & equipment, net 1,471,446 1,842,019 2,287,899 2,890,433 2,956,400
Other assets 85,561 72,893 186,917 219,422 261,100
Other intangible assets 26,800 35,409 37,955 42,043 66,600
26
Goodwill 68,950 92,474 161,478 215,625 266,500
Total assets 3,328,168 3,514,065 4,428,941 5,343,878 5,672,600
Commercial paper & short-term
borrowings - - - 710,248 713,000
Accounts payable 199,346 220,975 340,937 390,836 324,900
Accrued compensation & related costs 208,927 232,354 288,963 332,331 253,600
Accrued occupancy costs 65,873 44,496 54,868 74,591 136,100
Accrued taxes 63,038 78,293 94,010 92,516 76,100
Insurance reserves - - - - 152,500
Other accrued expenses 123,684 198,082 224,154 257,369 164,400
Deferred revenue 121,377 175,048 231,926 296,900 368,400
Current portion of long-term debt 735 748 762 775 700
Short-term borrowings - 277,000 700,000 - -
Total current liabilities 782,980 1,226,996 1,935,620 2,155,566 2,189,700
Deferred income taxes, net 46,683 - - - -
Senior notes - - - - 549,200
Other long-term debt - - - - 400
Long-term debt - - - - 549,600
Long-term debt 3,618 2,870 1,958 550,121 -
Deferred rent - - 203,903 271,736 303,900
Unrecognized tax benefits - - - - 60,400
Asset retirement obligations - - 34,271 43,670 44,600
Minority interest - - 10,739 17,252 18,300
Other long-term liabilities - - 13,944 21,416 15,200
Other long-term liabilities - - 262,857 354,074 442,400
Other long-term liabilities 8,132 193,565 - - -
Total liabilities - - 2,200,435 3,059,761 3,181,700
Common stock 956,685 90,968 756 738 700
Other additional paid-in capital 39,393 39,393 39,393 39,393 39,400
Retained earnings (accumulated deficit) 1,461,458 1,939,359 2,151,084 2,189,366 2,402,400
Net unrealized holding gains (losses) on
available-for-sale securities - - -254 1 -4,100
Net unrealized holding gains (losses) on
hedging instruments - - -6,416 -27,051 -22,200
Translation adjustment - - 43,943 81,670 74,700
Accumulated other comprehensive income
(loss) 29,219 20,914 37,273 54,620 48,400
Total shareholders' equity 2,486,755 2,090,634 2,228,506 2,284,117 2,490,900

27
Appendix B: 5tarbucks Historica| Income 5tatement
As Reported Annual Income Statement 10/03/2004 10/02/2005 10/01/2006 09/30/2007 09/28/2008
Currency USD USD USD USD USD
Auditor Status
Not
Qualified
Not
Qualified
Not
Qualified
Not
Qualified
Not
Qualified
Consolidated No No No No No
Scale Thousands Thousands Thousands Thousands Thousands

Company-operated retail revenue 4,457,378 5,391,927 6,583,098 7,998,265 8,771,900
Specialty licensing revenue 565,798 673,015 860,676 1,026,338 1,171,600
Specialty foodservice & other revenue 271,071 304,358 343,168 386,894 439,500
Total specialty revenue 836,869 977,373 1,203,844 1,413,232 1,611,100
Total net revenues 5,294,247 6,369,300 7,786,942 9,411,497 10,383,000
Cost of sales including occupancy costs 2,198,654 2,605,212 3,178,791 3,999,124 4,645,300
Store operating expenses 1,790,168 2,165,911 2,687,815 3,215,889 3,745,100
Other operating expenses 171,648 197,024 260,087 294,136 330,100
Depreciation & amortization expenses 280,024 340,169 387,211 467,160 549,300
General & administrative expenses 304,293 357,114 473,023 489,249 456,000
Restructuring charges - - - - 266,900
Total operating expenses 4,744,787 5,665,430 6,986,927 8,465,558 9,992,700
Income from equity investees 60,657 76,745 93,937 108,006 113,600
Operating income (loss) 610,117 780,615 893,952 1,053,945 503,900
Interest & other income, net 14,140 15,829 12,291 2,419 9,000
Interest expense - - - - 53,400
Earnings (loss) before income taxes 624,257 796,444 906,243 1,056,364 459,500
Current federal income taxes provision
(benefit) 188,647 273,178 332,202 326,725 180,400
Current state income taxes provision
(benefit) 36,383 51,949 57,759 65,308 34,300
Current foreign income taxes provision
(benefit) 10,218 14,106 12,398 31,181 40,400
Deferred income taxes provision (benefit),
net -2,766 -37,256 -77,589 -39,488 -111,100
Income taxes 232,482 301,977 324,770 383,726 144,000
Earnings before cumulative effect of
change in accounting principle - - 581,473 672,638 315,500
Cumulative effect of accounting change
for FIN 47, net of taxes - - -17,214 - -
Net earnings (loss) 391,775 494,467 564,259 672,638 315,500
Weighted average shares outstanding -
basic 794,346 789,570 766,114 749,763 731,500
Weighted average shares outstanding -
diluted 822,930 815,417 792,556 770,091 741,700
Year end shares outstanding 794,811.69 767,442.11 756,602.07 738,285.29 735,500
Earnings (loss) per share from continuing
operations - basic - - 0.76 0.9 0.43
Earnings (loss) per share - effect of
accounting change - basic - - -0.02 - -
Net earnings (loss) per share - basic 0.495 0.63 0.74 0.9 0.43
Earnings (loss) per share from continuing
operations - diluted - - 0.73 0.87 0.43
Earnings (loss) per share - effect of
accounting change - diluted - - -0.02 - -
Net earnings (loss) per share - diluted 0.475 0.61 0.71 0.87 0.43
Total number of employees 96,700 115,000 145,800 172,000 176,000
Number of common stockholders 13,095 13,900 16,653 18,500 21,000
28

Starbucks Corp.

As Reported Annual Retained Earnings 10/03/2004 10/02/2005 10/01/2006 09/30/2007 09/28/2008
Currency USD USD USD USD USD
Auditor Status
Not
Qualified
Not
Qualified
Not
Qualified
Not
Qualified
Not
Qualified
Consolidated No No No No No
Scale Thousands Thousands Thousands Thousands Thousands

Previous retained earnings (accumulated
deficit) 1,069,683 1,444,892 1,938,987 2,151,084 2,189,400
Cumulative impact for adoption of FIN 48 - - - - -1,700
Repurchase of common stock - - 352,162 634,356 100,800
Retained earnings (accumulated deficit) 1,461,458 1,939,359 2,151,084 2,189,366 2,402,400

29
Appendix C: 5tarbucks Historica| Cash F|ow 5tatement
As Reported Annual Cash Flow 10/03/2004 10/02/2005 10/01/2006 09/30/2007 09/28/2008
Currency USD USD USD USD USD
Auditor Status
Not
Qualified
Not
Qualified
Not
Qualified
Not
Qualified
Not
Qualified
Consolidated No No No No No
Scale Thousands Thousands Thousands Thousands Thousands

Net earnings (loss) 391,775 494,467 564,259 672,638 315,500
Cumulative effect of accounting change
for FIN 47, net of income taxes - - 17,214 - -
Depreciation & amortization 304,820 367,207 412,625 491,238 604,500
Provision for impairments & asset
disposals 13,568 20,157 19,622 26,032 325,000
Deferred income taxes, net -3,073 -31,253 -84,324 -37,326 -117,100
Equity in loss (income) of investees -33,387 -49,633 -60,570 -65,743 -61,300
Distributions of income from equity
investees - 30,919 49,238 65,927 52,600
Stock-based compensation - - 105,664 103,865 75,000
Tax benefit from exercise of nonqualified
stock options 63,405 109,978 - - -
Tax benefit from exercise of stock options - - 1,318 7,705 3,800
Excess tax benefit from exercise of stock
options - - -117,368 -93,055 -14,700
Net accretion of discount & amortization of
premium on marketable securities 11,603 10,097 - - -
Net amortization of premium on securities - - 2,013 653 -
Other adjustments - - - - -100
Accounts receivable - -49,311 - - -
Inventories -77,662 -121,618 -85,527 -48,576 -600
Prepaid expenses & other current assets -16,621 - - - -
Accounts payable 27,948 9,717 104,966 36,068 -63,900
Accrued compensation & related costs 54,929 22,711 54,424 38,628 -
Accrued occupancy costs 8,900 - - - -
Accrued taxes - - 132,725 86,371 7,300
Deferred revenue 47,590 53,276 56,547 63,233 72,400
Other accrued expenses 16,465 - - - -
Other operating assets & liabilities -16,412 56,894 -41,193 -16,437 60,300
Net cash flows from operating activities 793,848 923,608 1,131,633 1,331,221 1,258,700
Purchase of available-for-sale securities -566,645 -643,488 -639,192 -237,422 -71,800
Maturity of available-for-sale securities 163,814 469,554 269,134 178,167 20,000
Sale of available-for-sale securities 190,748 626,113 431,181 47,497 75,900
Acquisitions, net of cash acquired - -21,583 -91,734 -53,293 -74,200
Net purchases of equity, other
investments & other assets -64,747 -7,915 -39,199 -56,552 -52,000
Net additions to property, plant &
equipment -386,176 -643,989 -771,230 -1,080,348 -984,500
Purchase of Seattle Coffee Company, net -7,515 - - - -
Distributions from equity investees 38,328 - - - -
Net cash flows from investing activities -632,193 -221,308 -841,040 -1,201,951 -1,086,600
Repayments of commercial paper - - - -16,600,841 -66,068,000
Proceeds from issuance of commercial
paper - - - 17,311,089 65,770,800
Repayments of short-term borrowings - - - -1,470,000 -228,800
30
Proceeds from short-term borrowings - - - 770,000 528,200
Proceeds from issuance of common stock 137,590 163,555 159,249 176,937 112,300
Excess tax benefit from exercise of stock
options - - 117,368 93,055 14,700
Principal payments on long-term debt -722 -735 -898 -784 -600
Proceeds from issuance of long-term debt - - - 548,960 -
Repurchase of common stock -203,413 -1,113,647 -854,045 -996,798 -311,400
Borrowings under revolving credit facility - 277,000 423,000 - -
Other financing activities - - - -3,505 -1,700
Net cash flows from financing activities -66,545 -673,827 -155,326 -171,887 -184,500
Effect of exchange rate changes on cash
& cash equivalents 3,111 283 3,530 11,272 900
Net increase (decrease) in cash & cash
equivalents 98,221 28,756 138,797 -31,345 -11,500
Cash & cash equivalents, beginning of
period 200,907 145,053 173,809 312,606 281,300
Cash & cash equivalents, end of period 299,128 173,809 312,606 281,261 269,800
Cash paid during the period for interest,
net of capitalized interest 370 1,060 10,576 35,294 52,700
Cash paid during the period for income
taxes 172,759 227,812 274,134 342,223 259,500
31
Appendix C: Oiscounted Free Cash F|ow to the Firm ~ Oetai|ed
Pro|ections
2004 A 2005 A 2006 A 2007 A 2008 A

(Estimated) Company-operated
retail revenue 4,457,378 5,391,927 6,583,098 7,998,265 8,771,900
(Estimated) Company-operated
retail revenue growth - 0.209663394 0.220917494 0.21496976 0.096725352

(Estimated) Speciality licensing
revenue 565,798 673,015 860,676 1,026,338 1,171,600
(Estimated) Specialty licensing
revenue growth - 0.189496958 0.278836282 0.192478935 0.14153427

(Estimated) Speciality foodservice
and other revenue 271,071 304,358 343,168 386,894 439,500
(Estimated) Specialty foodservice
and other revenue growth - 0.122798086 0.127514309 0.12741864 0.135970059

(Estimated) Total net revenues 5,294,247 6,369,300 7,786,942 9,411,497 10,383,000
(Estimated) Total net revenues
growth - 0.203060605 0.222574223 0.208625543 0.10322513

(Estimated) Cost of sales including
occupancy costs 2,198,654 2,605,212 3,178,791 3,999,124 4,645,300
(Estimated) Cost of sales including
occupancy costs - 0.184912224 0.22016596 0.258064465 0.161579386

(Estimated) Total operating
expenses 4,744,787 5,665,430 6,986,927 8,465,558 9,725,800
(Estimated) Total operating
expenses growth - 0.194032525 0.233256258 0.211628231 0.148866974

(Estimated) EBIT 624,257 796,444 906,243 1,056,364 779,800
(Estimated) EBIT growth - 0.275827103 0.137861545 0.165652038 -0.261807483

(Estimated) Net earnings 391,775 494,467 564,259 672,638 315,500
(Estimated) Net earnings growth - 0.262119839 0.141145921 0.192073144 -0.530951269

(Estimated) Gross margin 0.584708836 0.590973576 0.591779289 0.575080989 0.55260522
(Estimated) EBIT Margin 0.11791233 0.125044196 0.116379832 0.112241868 0.075103535
(Estimated) Profit margin 0.074000136 0.077632864 0.072462207 0.07146982 0.030386208

(Estimated) Depreciation &
amortization expenses 280,024 340,169 387,211 467,160 549,300
(Estimated) Depreciation &
amortization expenses growth - 0.214785161 0.138290085 0.20647399 0.17582841
% of PP&E 0.104620036 0.102396575 0.094841778 0.091757048 0.096076819

Effect Income Tax Rate 0.372413926 0.379156601 0.358369665 0.363251682 0.313384113
Weight 0.1 0.1 0.1 0.3 0.4
Weighted Effective Tax Rate 0.037241393 0.03791566 0.035836966 0.108975505 0.125353645


32

2009 E 2010 E 2011 E 2012 E 2013 E

(Estimated) Company-operated retail
revenue
(Estimated) Company-operated retail
revenue growth

(Estimated) Speciality licensing
revenue
(Estimated) Specialty licensing revenue
growth

(Estimated) Speciality foodservice and
other revenue
(Estimated) Specialty foodservice and
other revenue growth

(Estimated) Total net revenues 9,811,252 9,541,120 10,495,232 11,544,755 12,699,231
(Estimated) Total net revenues growth -0.055065761 -0.02753288 0.1 0.1 0.1

(Estimated) Cost of sales including
occupancy costs
(Estimated) Cost of sales including
occupancy costs

(Estimated) Total operating expenses
(Estimated) Total operating expenses
growth

(Estimated) EBIT 327,948 327,948 344,346 361,563 379,641
(Estimated) EBIT growth -0.676265271 0 0.05 0.05 0.05

(Estimated) Net earnings
(Estimated) Net earnings growth

(Estimated) Gross margin
(Estimated) EBIT Margin
(Estimated) Profit margin

(Estimated) Depreciation &
amortization expenses 518,682 504,401 534,291 576,418 621,627
(Estimated) Depreciation &
amortization expenses growth
% of PP&E 0.0979 0.0979 0.0979 0.0979 0.0979

Effect Income Tax Rate
Weight
Weighted Effective Tax Rate


33

Analysis of Fixed Capital Investment 2004 A 2005 A 2006 A 2007 A 2008 A

(Estimated) Property, plant &
equipment, at cost 2,676,581 3,322,074 4,082,705 5,091,271 5,717,300
(Estimated) Property, plant &
equipment, at cost growth - 0.24116326 0.22896269 0.247033768 0.122961241
Change in PP&E 645,493 760,631 1,008,566 626,029
% of Net Revenues 0.505564058 0.521575997 0.524301452 0.540962931 0.55064047

Analysis of Net Working Capital
2004 2005 2006 2007 2008
Current Assets - Cash 770,229 861,716 904,576 1,415,226 1,478,200
Current Liab - ST Debt 782,245 949,248 1,234,858 1,444,543 1,476,000
NWC -12,016 -87,532 -330,282 -29,317 2,200
NWC_Change - -75,516 -242,750 300,965 31,517
CAGrowth 0.118778961 0.049737965 0.564518625 0.044497487
CLGrowth 0.213491937 0.300880276 0.169804949 0.021776437
0.1 0.1 0.3 0.5
Weighted_CAGrowthRate 0.011877896 0.004973796 0.169355588 0.022248743
Weighted_CLGrowthRate 0.021349194 0.030088028 0.050941485 0.010888219

FCFF from EBIDTA

EBIT(1-T) 391,775 494,467 581,473 672,638 535,423
+Dep 280,024 340,169 387,211 467,160 549,300
-FCInv - 645,493 760,631 1,008,566 626,029
-WCInv - -75,516 -242,750 300,965 31,517

FCFF = 264,659 450,803 -169,733 427,177

FCFF from CFO

(Estimated) Cash flow from
operations 793,848 923,608 1,131,633 1,331,221 1,258,700
(Estimated) Cash flow from
operations growth 0.163456984 0.225230834 0.176371668
-
0.054477055

+ Int(1-Tax Rate) 34,961
-FCInv - 645,493 760,631 1,008,566 626,029

FCFF = 278,115 371,002 322,655 667,632
34

Analysis of Fixed Capital Investment 2009 E 2010 E 2011 E 2012 E 2013 E

(Estimated) Property, plant & equipment, at
cost 5,298,076 5,152,205 5,457,521 5,887,825 6,349,615
(Estimated) Property, plant & equipment, at
cost growth
Change in PP&E -419,224 -145,871 305,316 430,305 461,790
% of Net Revenues 0.54 0.54 0.52 0.51 0.5

Analysis of Net Working Capital
2009 2010 2011 2012 2013
Current Assets - Cash 1,765,562 2,108,787 2,518,736 3,008,378 3,593,206
Current Liab - ST Debt 1,736,514 2,043,009 2,403,600 2,827,835 3,326,948
NWC 29,048 65,779 115,136 180,543 266,258
NWC_Change 26,848 36,731 49,357 65,407 85,716
CAGrowth 0.1944 0.1944 0.1944 0.1944 0.1944
CLGrowth 0.1765 0.1765 0.1765 0.1765 0.1765

Weighted_CAGrowthRate
Weighted_CLGrowthRate

FCFF from EBIDTA

EBIT(1-T) 214,708 214,708 225,443 236,715 248,551
+Dep 518,682 504,401 534,291 576,418 621,627
-FCInv -419,224 -145,871 305,316 430,305 461,790
-WCInv 26,848 36,731 49,357 65,407 85,716

FCFF = 1,125,765 828,249 405,061 317,422 322,672

FCFF from CFO

(Estimated) Cash flow from operations 1,080,846 1,004,484 1,024,574 1,055,311 1,097,523
(Estimated) Cash flow from operations
growth -0.1413 -0.07065 0.02 0.03 0.04

+ Int(1-Tax Rate) 34,961 34,961 34,961 34,961 34,961
-FCInv -419,224 -145,871 305,316 430,305 461,790

FCFF = 1,535,030 1,185,316 754,219 659,967 670,694
35
Appendix O: Va|uation App|ication
2009 2010 2011 2012 2013 Terminal
FCFF From
EBIT 1,125,765 828,249 405,061 317,422 322,672
FCFF From
CFO 1,535,030 1,185,316 754,219 659,967 670,694

Target D/E Ratio: 0.180759743

Cost of Equity:

Risk Free Rate: 0.02
Beta: 0.93
Market Risk Premium: 0.065
0.08045

Cost of Debt: 0.0425555

WACC: 0.0736002

FCFF Growth Rate: 0.04

PV of FCFF
(EBIT) 1,048,589 718,581 327,335 238,928 226,229 7,002,296

Value of the Firm: 9,561,959
Less: Debt 549,600
Value of Equity: 9,012,359

Weighted average shares oustanding:
Basic: 731,500
Diluted: 741,700

Intrinsic Value:
Basic: 12.32038187
Diluted: 12.15094963

PV of FCFF
(CFO) 1,429,797 1,028,369 609,494 496,766 470,231 14,554,691

Value of the Firm: 18,589,349
Less: Debt 549,600
Value of Equity: 18,039,749

Weighted average shares oustanding:
Basic: 731,500
Diluted: 741,700

Intrinsic Value:
Basic: 24.66131145
Diluted: 24.32216439
36

Growth Rate
3% 4% 5%
Firm Value 7,904,048 9,561,959 12,624,868
Equity Value 7,354,448 9,012,359 12,075,268
Implied Share Value
Basic $10.05 $12.32 $16.51
Diluted $9.92 $12.15 $16.28