Compute the required rate of return on equity capital

Reference no: EM131445868

Problem -

The following table provides hypothetical balance sheet data for three firms NMG, HES, and MGMT. Existing market betas and well as analysts' consensus forecast of net income for year + 1 also has been provided. Assume that the comprehensive income and net income are identical for year + 1 (analysts expect the other comprehensive income items for year + 1 to be zero). Assume that the risk-free rate of return is 3% and the market risk premium is 6%.

(dollar amounts in millions)	NMG	HES	MGMT
Total Assets	$45,329	$113,235	$46,560
Common Equity:
Book Value	$16,152	$14,336	$12,956
Market Value	$18,150	$162,620	$33,450
Market Equity Beta	0.29	0.76	1.12
Analysis' Consensus Forecasts of Net Income for Year +1	$5,760	$12,966	$2,484

Questions:

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. Rank the three firms using expected residual income for Year + 1 relative to book value of common equity.

e. 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.

Reference no: EM131445868

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