The CAPM method in this case gives a more accurate picture of the discount rate that should apply to Starbuck’s. The reason being that the formula for WACC takes into account the current share price in the form of Market Capitalization. This number reflects the price that Starbuck’s must pay its shareholders for their investment.
This stock price has more than doubled over the past year and this is reflected in the WACC calculation. This type of growth is rare and it is questionable whether it will be maintained.The Cost of Capital takes into account how much a company must pay for financing. This does not only cover long tern debt secured through a bank, but must also take into account financing that is achieved through shareholders.
When using the WACC method, stock price will severely effect the Cost of Capital. The CAPM is based on stable market indicators and in this case, is the more accurate indicator for Cost of Capital, due to the unusual increase in stock price reflected in the WACC method.Starbuck’s is in a constant quest to develop more market share by opening more shops and engaging in new endeavors. It is currently trying to enter into online sales of its products.
Starbuck’s coffee and other products are high priced as compared to other similar products. This limits their potential customer base to the upper income levels. Starbuck’s could lower their cost of financing by slowing down their growth and expansion, which requires borrowing capital, and developing a more stable rimary customer base, perhaps offering some lower priced items.Starbuck’s has a large amount of money invested in shareholder’s equity.
This of course makes the shareholders happy, but puts a large financial burden on Starbucks. Long term debt through financial institutions is low for Starbucks. The main area that needs improvement is in the stock owed to investors. Starbuck’s could reduce their Cost of Capital through a share re-purchase plan.
