The Following Data Represent Total Assets,book Value,and Market Value of Common

question 24

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.
$\begin{array}{|l|c|c|c}\text { (dollar amounts in millions) } & \text { Amore } & \text { Infact } & \text { Tickle } \\\hline \text { Total Assets } & \$ 42,419 & \$ 109,524 & \$ 44,106 \\\hline \text { Common Equity: } & & & \\\hline \text { Book Value } & \$ 17,480 & \$ 13,466 & \$ 13,712 \\\hline \quad \text { Market Value } & \$ 83,050 & \$ 166,420 & \$ 34,600 \\\hline \text { Market Equity Beta } & 0.27 & 0.73 & 1.09 \\\hline \begin{array}{l}\text { Analysts' Consensus Forecasts of Net } \\\text { Income for Year }+1\end{array} & \$ 5,750 & \$ 12,956 & \$ 2,384 \\\hline\end{array}$
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.

Understand the differences between the cost of debt and the cost of equity and their implications for the WACC.

Comprehend how corporate tax rates influence the after-tax cost of debt and WACC.

Analyze the effects of changes in capital structure on WACC.

Apply the appropriate cost of capital for evaluating capital budgeting projects based on funding sources.

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Definitions:

Profit-Maximizing Firm

A company that operates in such a way as to maximize its profits by determining the best levels of production and pricing.

Interest-Rate Cost of Funds

The expense associated with borrowing money, typically represented as a percentage of the total amount borrowed.

Corporate Decision

Strategic choices made by a company’s management that influence its operations, finances, and overall business direction.

R&D Activity

Research and Development activities involve investigative projects to discover new knowledge and use it to develop new products, processes, or services.