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

question 27

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.
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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Definitions:

Kilocalories

A unit of energy measurement in nutrition, commonly called a calorie, equivalent to 1000 small calories.

Energy Content

The amount of energy stored in a substance or system, which can be released or utilized through various processes.

Lipid

Substance composed principally of carbon, oxygen, and hydrogen; contains a lower ratio of oxygen to carbon and is less polar than carbohydrates; generally soluble in nonpolar solvents.

Carbohydrate

Monosaccharide (simple sugar) or the organic molecules composed of monosaccharides bound together by chemical bonds—for example, glycogen. For each carbon atom in the molecule, there are typically one oxygen molecule and two hydrogen molecules.