The Following Data Represent Total Assets, Book Value, and Market

question 25

Essay

The following data represent total assets, book value, and market value of common shareholders' equity for Amore, Infact, and Tickle. Amore manufactures and sells cosmetics. Infact develops and manufactures computer chips. Tickle operates a chain of general merchandise stores. In addition, these data include existing market betas for the three firms and analysts' consensus forecasts of net income for Year +1
Assume that for each firm, analysts expect other comprehensive income items for
Year +1 to be zero; so Year +1 net income and comprehensive income will be identical.
Assume that the risk-free rate of return in the economy is 4.5 percent and the market risk
premium is 5.5 percent.
$\begin{array}{c}\begin{array}{|l|} \hline \text {(dollar anounts in millions)}\\ \hline \text {Total Assets}\\ \hline \text {Common Equity:}\\ \hline \text {Book Value}\\ \hline \text {Market Value}\\ \hline \text {Market Equity Beta}\\ \hline \text {Analysts' Consensus Forecasts of Net Income for Year +1}\\ \hline \end{array}\begin{array}{l|} \hline \text { Amore }\\ \hline \$ 42,419\\ \hline \\ \hline \$ 17,480 \\ \hline \$ 83,050 \\\hline \$ .27 \\ \hline \$ 5,750\\ \hline \end{array}\begin{array}{l|} \hline \text { Infact}\\ \hline \$ 109,524\\ \hline\\ \hline \$ 13,466 \\ \hline\$ 166,420 \\ \hline 0.73 \\ \hline\$ 12,956 \\ \hline \end{array}\begin{array}{l|} \hline \text { Tickle}\\ \hline \$ 44,106 \\ \hline \\ \hline \$ 13,712\\ \hline \$ 34,600 \\ \hline 1.09 \\ \hline \$ 2,384 \\ \hline \end{array} \end{array}$
Required
a. Using the CAPM, compute the required rate of return on equity capital for each
firm.
b. Project required income for Year +1 for each firm.
c. Project residual income for Year +1 for each firm.
d. What do the different amounts of residual income imply about each firm? Do the
projected residual income amounts help explain the differences in market value of
equity across these three firms? Explain.

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