Finance

Starbucks began operating in 1971 in Seattle. By 1992, it had grown into a public company with over 160 outlets. Starbucks Corporations shares are listed and traded NASDAQ, under the trading symbol SBUX. While it initially started with roasting and selling coffee, tea and spices, Starbucks Corporation of today has a lot more to offer. (Company Profile, 2010)

Type of Products Offered
Starbucks Corporation sells 30 blends and single origin premium Arabica coffees, fresh brewed coffee, hot and iced espresso beverages, coffee and non coffee blended beverages, Vivanno smoothies and Tazo teas. Apart from the different types of coffee and tea, Starbucks Corporation also sells beverage related accessories and equipment including home espresso machines, coffee brewers and grinders, coffee mugs, packaged goods, music, books and gift items. Among eateries, Starbucks offers baked pastries, sandwiches, salads, oatmeal, and yoghurt parfaits and fruit plates. Other of its products include the bottled Starbucks Frappuccino beverages, Starbucks Discoveries chilled cup coffee, Starbucks DoubleShot espresso drinks, Iced Coffee, whole bean coffee, ice creams etc (Investor Relations, 2009) (Company Profile, 2010).

Countries It Operates In
As of 2009, Starbucks Corporation boasts of almost 17000 stores, among which only 7856 are licensed stores while the rest are company operated. The company operates in more than 50 countries, the list of which is given below.

Argentina, Aruba , Australia, Austria, Bahamas, Bahrain, Belgium, Brazil, Bulgaria, Canada, Chile, China, Cyprus, Czech Republic, Denmark, Egypt, France, Germany, Greece, Hong Kong, Indonesia, Ireland, Japan, Jordan, Korea, Kuwait, Lebanon, Malaysia, Mexico, New Zealand, Netherlands, Northern Ireland, Oman, Peru, Philippines, Poland, Portugal, Qatar, Romania, Russia, Saudi Arabia, Scotland, Singapore, Spain, Switzerland, Taiwan, Thailand, Turkey, United Arab Emirates, United States and Wales. (Company Profile, 2010)

Size Relative to Industry
Starbucks Corporation enjoys 1.7 of the total market share (TNS Media Intelligence). Coffee consumption in America has increased as consumers become more informed about different varieties and qualities of coffees that exist. The coffee market has faced challenges in the form of rising coffee bean and milk prices, however, the not-so-declining sales growth of various coffee companies have confirmed the existence of a relative inelastic demand for coffee. The National Coffee Association estimates that the US coffee market will reach 29 billion in 2011, while the Starbucks market capitalization in 2009 amount to 19,372.6 million (US and other countries) (Annual Report 2009, 2009) (The National Coffee Association, 2008).

Performance over the last 23 years
The year 2009 saw Starbucks Corporation reducing its stores from 16, 680 to 16,635 as part of its restructuring plan but the stores were still 1624 more than from the year 2007. As mentioned in the annual report, Starbucks Corporation faced increasing challenges during the recent years in the form of new competitors, changing consumer demands, global recession and complacency on the part of the company. In the wake of the aforementioned challenges, the net revenues of the company dipped to 9.8 billion from 10.4 billion of the year 2008, a 5.7  decrease. However, the net revenue figure was still a slight improvement from the year 2007, standing at 9.4 billion. Starbucks Corporation faced a 6 decline in its relative sales growth as compared to the year 2008 - its second year in declining sales growth since 2007, the major cause of the decline being slow customer turnout at the stores due to increased competition coupled with recession. The operating income of the company however, increased 54 million to 894 million from the year 2008 but slid down from the 2007s operating income of 1054. (Starbucks Coffee Company Annual Report 2009, 2010)

Starbuckss diluted earnings per share performed better by increasing to 0.80 from 0.71 of 2008  a percentage increase of 12.6. However, in 2007, the diluted EPS stood at 0.87. Starbucks seemed to have fared better in cash flow management as its cash from operations increased to 1389 from 1259 of the year 2008 and 1331 of the year 2007. The company spent less on its capital expenditures in 2009 than in the previous years, probably savings its reserves for the time when the company experienced greater sales growth. (Starbucks Coffee Company Annual Report 2009, 2010)

Financial Structure and Comparison
In the year 2009, Starbucks Corporation financed its assets from 3045.7 million equity and 2531 million of liabilities. Thus, the total assets of the company amounted to 5576.8 million in 2009. The accounts payable of the company decreased 12 from 304.9 million to 267.1 million implying better credit control and cash management by the company. The current portion of long term debt decreased from 0.7 million to 0.2 million, depicting declining debt burden on the company (a 72 decrease to be exact) (Starbucks Coffee Company Annual Report 2009, 2010).

The total current liabilities of the company decreased from 2189.7 million to 1581 million in 2009, thus improving the quality of its earnings as they are being less financed by debt and more by equity. Starbucks long term debt also decreased 0.3 million since 2008 while its other long term liabilities saw a decline of approximately 42 million (Starbucks Coffee Company Annual Report 2009, 2010). Analyzing only these basic figures clearly shows that Starbucks had its debts well managed and has no imminent liquidity problems.

Starbucks current ratio current assetscurrent liabilities stands at 1.28, implying that for every  of liability, they have 0.28 assets more to pay it off. (Starbucks Coffee Company Annual Report 2009, 2010) Caribou Coffee Company one of Starbucks competitors has a better current ratio of 1.44, implying a better liquidity position than that of Starbucks, even though its total current assets and liabilities are considerably lower than that of Starbucks (Caribou Coffee Annual Report 2009, 2010). Starbucks quick ratio current assets  inventory current liabilities for the year 2009 stands at 0.86, a ratio that is quite low from its current ratio and is less than 1, implying that leaving inventories aside, Starbucks has a deficit of 0.13 of assets for every  worth of liabilities they have (Starbucks Coffee Company Annual Report 2009, 2010).

Compared to Caribou whose quick acid test ratio amounts to 1.02, Starbucks quick ratio is worse off. While Caribou has an additional 0.02 of assets (excluding inventories) for every dollar worth of liabilities, Starbucks face a deficit portraying that Starbucks liquidity position is lower than that of Caribous (Starbucks Coffee Company Annual Report 2009, 2010) (Caribou Coffee Annual Report 2009, 2010). However, one important consideration to be taken into account is of the inventory valuation methods used by both the coffee chains. If Starbucks is using First In First Out method of valuing inventory in times of rising prices, its closing inventory would show the cost of inventory at inflated prices, thus giving its inventory figure a greater total decreasing its quick acid test ratio. For the aforementioned considerations, it is imperative to not consider the ratios in isolation and carefully study the accounting policies, methods and estimates used by the companies being analyzed and compared. (Financial Ratio Explanations)

Leverage ratios are used to depict the solvency of the company. While liquidity ratios predict the short term ability of the company to survive, the leverage ratios can be used to identify whether a company is moving towards bankruptcy or has enough assets to survive in the long term. The debt to assets measure total assets against total liabilities while the debt to equity ratio measures total liabilities against the total shareholder equity. (Financial Ratio Explanations) The debt to asset ratio for Starbucks for the year 2009 is 2.2, indicating that it has enough total assets to pay off its liabilities in the long run (Starbucks Coffee Company Annual Report 2009, 2010). However, Caribous debt to asset ratio equals to 8.29, a considerably better ratio than that of Starbucks. Analyzing the ratios clearly presents Caribou in a favorable light as compared to Starbucks as far as liquidity and solvency of the company are concerned. (Caribou Coffee Annual Report 2009, 2010)

The debt to equity ratio that measures the ability of a company to borrow funds from the capital market should preferably be lower, as a company with a high debt to equity ratio may be find that its borrowing capacity is quite limited as banks prefer lending to companies that are not very leveraged (Financial Ratio Explanations). The debt to equity ratio of Starbucks is 0.83 while for Caribou it is 0.22, again a considerably better leverage ratio than that of Starbucks (Starbucks Coffee Company Annual Report 2009, 2010) (Caribou Coffee Annual Report 2009, 2010).

The debt to capital ratio of the company gives an idea of the financial structure. It is measured by dividing total debts by a sum of equity plus debt. The higher the ratio, the more a company is taken to be geared. A high debt to capital ratio indicates that a company lacks in financial strength. Starbucks debt to capital ratio is 0.45, while for Caribou it is 0.12. Even though, the ratio for Starbuck does not really indicate a threat to the continuity of the company, it is quite worse than that of Caribou, implying a much greater reliance on debt for financing its operations (Starbucks Coffee Company Annual Report 2009, 2010) (Caribou Coffee Annual Report 2009, 2010).

Synoptically, the financial structure of Caribou is much better than that of Starbucks. However, considering the ratios of Starbucks from a stand-alone point, they do not portray an alarming picture and are reasonable enough for a coffeehouse. In fact, its liquidity ratios show that its working capital is well managed and efforts have been made to keep the company from borrowing excessively. 
Weighted Average Cost of Capital
The WACC of a company is calculated as follows
Wd rd (1-t)  wprp were
Where Wd is the proportion of debt that the company uses when it raises new funds. Rd is the before tax marginal cost of debt. T is the companys marginal tax rate. Wp is the proportion of preferred stock the company uses when it raises new funds. Rp is the marginal cost of preferred stock. We are the proportion of equity that the company uses when it raises new funds. Re is the marginal cost of equity (Curriculum, 2009).
Ke 1.2 1.2 1  kd (1- tax) 0.83 0.831

There are several methods of estimating the cost of equity. One of them is called the dividend discount model, which uses growth in dividends to identify the expected of equity and the capital asset pricing model. Capital is not tax deductible so no adjustment is made to it as in cost of debt. The weights in the formula are calculated from the market values of equity and debt. However, in this case since no information has been given about the market value, we have assumed the book value to be the market value of both equity and debt.
As Starbucks has never paid dividends on its ordinary shares, the Dividend Discount Model cannot be used to estimate the cost of equity.  Through the CAPM model,
Ke  Rf  Beta (Market risk Premium)

The yield on 12 month Treasure bonds is 0.25 so we assume the Rf is 0.25. The Market risk is 4.820 which makes the market risk premium 4.57. Assuming a beta of 1, the cost of equity comes to be 4.82. (SP 500 Index Summary, 2010)

The cost of debt can be calculated from the yield to maturity approach that uses the IRR (internal rate of return) method to calculate the yield. It is the annual return that an investor earns on a bond if the investor purchases the bond now and holds it till maturity.  The other method is through following the debt rating agencies.

Description of the Project
Assuming Starbucks has the finance and equity to finance the project, the company can invest in delivery vehicles that can enable Starbucks to supply food and beverages to offices or universities or in homes. To compensate for the increased cost, Starbucks can charge a minimal amount on delivery, say, 2 of the full value of the order. Consistent with the objective of Starbucks of expanding the Starbuck experience to new territories, the project can be a viable option and will increase Starbucks outreach in the existing markets and bring back its lost customers.

Identifying Costs
The initial investment cost can be identified by contacting realtors in India about promising locations and cost of them. As Starbucks will be entering into a new market, it is imperative to consider all options of entry and exit (in case of unsuccessful results). The company should consider leasing the premises as opposed to buying, as it will manage its cash flow more effectively. The annual revenues can be estimated by determining the demand in the area, by carrying out market research, competitors price and revenues, their market shares and the purchasing power of the people. The annual operating costs will include such expenses as the costs of running the store, from electricity expenses to rental leases etc. These costs, again can be estimated by considering a competitor in the region. Inflation rates can be estimated from the Consumer Price Index of the country while the tax rates, reliefs and allowances can be estimated by the most recent fiscal budget or government press releases and announcements. 

Dealing with Uncertainty and Risk
As an appraisal of investments uses a lot of forecasts and uncertainty in their financial evaluation of the project, it is necessary that the uncertainty can be quantified and estimated in some way to be incorporated in the investment appraisal. One way to incorporate risk and uncertainty is to use sensitivity analysis. The analysis starts by asking what if questions. For example, What if the cost of raw materials increased by 10 Will the project still be profitable Would there be any cash flow problems Etc.  (Lynch, 2008).

Other methods of incorporating uncertainty in the analysis are of simulation and expected values. Expected value is the weighted average of all the possible outcomes, with the weightings based on the probability estimates. It is not the most likely result but it identifies the long run average outcome. Simulation goes further than sensitivity analysis by finding out the impact of changing more than 1 variable all at once. Using mathematical models, it produces a distribution of the possible outcomes from the project. The probability of different outcomes can then be calculated. (Lynch, 2008)
Financial Forecast and NPV with the incorporation of uncertainty and risk
Years20092010201120122013 onwardsCost of delivery vans(20000)Incremental Sales 8000 8725 12000 17000Fuel costs (1000) (1000)(1500) (2000)Staff costs (1000) (1000) (1000) (1000)Repair and Maintenance(1000)Tax payable  30(1800)(2017)(2850)(3900)Net cash flow(20,000)4200470766509100Discount Factor (WACC) 5PV(20,000)4000426957447486NPV  1499

Uncertainty needs to be incorporated in the analysis by carrying out sensitivity analysis. It is calculated from the following formula
Sensitivity margin  Net Present Value Present Value of parameter to be considered X 100
The higher the sensitivity margin, the less sensitive the decision will be to the parameter being considered. Small changes in the estimated would not the change the project decision from accept to reject (Lynch, 2008).

Sensitivity to initial investment  1499 20000 X 100  7.5
An increase of 7.5  in the cost of investment of the delivery vans will cause the NPV to fall to 0. The NPV is highly sensitive to the cost of investment and even a slight increase in the cost of the delivery vans are likely to impact NPV adversely by a greater amount, making the project unprofitable.
Sensitivity to Fuel Costs  1499 2000 X 100  74.5

An increase of 745 in the fuel costs will cause the NPV to fall to 0. If the percentage increase in the price is greater than B, the NPV will be negative and the project will not viable.
However, there are disadvantages to using sensitivity analysis. It assumes that the variables change independently of each other and does not incorporate the impact of changing variables on other variables, apart from the NPV. It does not incorporate the probability of a variable changing and has no clear decision rule of accepting a decision (Lynch, 2008) (Curriculum, 2009).

Quarterly Report
To Board of Directors
From Project Managers
Subject Project Performance
Period  Jan  March 2009

The first quarter since the project has been started has seen a right hand shift in the demand by consumers. Most of the demand has come from workplaces, during the 9 to 5 slab. The increased demand from free delivery of Starbucks food and beverages has also eaten away some of the demand from its coffeehouses because of a process called cannibalization. However, we have developed a plan to increase revenue from the project by improving the marketing strategy, rebuilding customer loyalty and by offering various discount deals.
Below is the budgeted performance of the project and its actual performance for the quarter Jan  March 2009.

YearsBudgeted Actual DifferenceIncremental Sales20001800200Fuel costs250350100Staff costs250250-Repair and MaintenanceTax payable  30450360Net cash flow1050840210
The net cash flow is 210 less than budgeted because of the following reasons
The fuel costs estimated for the duration was understated. The increase in fuel costs have increased the costs of delivering by almost 40 which is a substantial increase in costs.
Staff costs were correctly predicted but as demand increases, there will a need for more delivery vans and drivers, thus an increase in variable costs are likely.

Also, no expenses were made for repair and maintenance as the delivery vans are new but the vans are required go for maintenance check semi-annually which will further increase the cost of the project.

Increasing the demand for the products cannot be undermined if the project is to stay profitable in the long run. Improved marketing strategy and better consumer deals have to be used to attract consumers in times of rising prices and recession.