Return on Capital and Cost of Capital: How does their Relation Affect Firm Value?

The Great Recession of 2008-2009 hurt almost all of the companies’ stock values in the United States. Interestingly, for Starbucks, the deterioration started a few years before the recession. From 2005 to 2007, the company’s stock price declined by approximately 40%. This case encourages students to examine the company’s return on capital, compare it to its cost of capital, and then relate this to the decline in the company’s stock price. First, they will establish a single formula for return on invested capital. Then, they will calculate the return on invested capital for Starbucks in each year. They will learn about different costs of capital including cost of common stock, cost of preferred stock, and cost of debt. Then, they will debate whether cost of debt capital, cost of equity capital, or weighted-average cost of capital is the relevant number to compare to the company’s return on invested capital. Overall, the case illustrates the importance of return on capital, the different types of cost of capital, and the overall cost of capital on a company’s value.