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Computing Residual Income. Suppose the following hypothetical data represent total assets, book value, and market value of common shareholders’ equity (dollar amounts in millions) for three firms. Each of these firms, Southwest Airlines, Kroger, and Yum! Brands, operates in a different industry, but all of them operate in very competitive industries. Southwest Airlines is a U.S. domestic airline that provides low-cost point-to-point air transportation services. Kroger operates retail supermarkets across the United States. Yum! Brands operates and franchises quick-service restaurants, including KFC, Pizza Hut, Taco Bell, Long John Silver’s, and A&W All American Food restaurants. These data also include hypothetical market betas for the three firms and analysts’ consensus forecasts of net income for Year þ1. For each firm, analysts expect other comprehensive income items for Year þ1 to be zero; so Year þ1 net income and comprehensive income will be identical. Assume that the risk-free rate of return in the economy is 4.0% and the market risk premium is 5.0%. Southwest Airlines Kroger Yumi Brands Total Assets 14308 23211 7242 Common equity Book value 4953 5176 1139 Market value 7490 14870 15950 Market equity beta 1.10 .35 1.04 Analysts’ consensus forecasts of net income for Year +1 252 1263 1010 a. Using the CAPM, compute the required rate of return on equity capital for each firm. b. Project required income for Year þ1 for each firm. c. ProjectresidualincomeforYearþ1foreachfirm. d. Rank the three firms using expected residual income for Year þ1 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.
E-Eyes.com Bank just issued some new preferred stock. The issue will pay an annual dividend of $16 in perpetuity, beginning 5 years from now. If the market requires a return of 3.0 percent on this investment, how much does a share of preferred stock ..
Assume that your father is now 50 years old, that he plans to retire in 10 years, and that he expects to live for 25 years after he retires - that is, until he is 85. He wants his first retirement payment to have the same purchasing power at the time..
The risk free rate is 7%, the return in the market is 10%, and the beta is 1.30. What return must you receive to be satisfied that you are being fairly compensated for the risk of the firm? What is the excel formula to solve this? What is the yield ..
Explain BMW's claim that under the new bonus program, "upper-level management could potentially lose more money than their lower-level counterparts for bad performance."
Templeton extended care facilities is considering the acquisition of a chain of cemeteries for $400 million since the primary asset of this business is real estate Templeton’s management has determined that they will be able to borrow the majority of..
George Bennet wants to give his son $20,000 upon completion of his college education. If he invests $5,500 now in an account earning 9% annual interest, approximately how many years will it take for him to achieve his goal?
An unlevered firm has a value of $900 million. An otherwise identical but levered firm has $50 million in debt at a 5% interest rate. Its cost of debt is 5% and its unlevered cost of equity is 12%. After Year 1, free cash flows and tax savings are ex..
After researching Valero Energy common stock, Sandra Pearson is convinced the stock is overpriced. She contacts her account executive and arranges to sell short 270 shares of Valero Energy. At the time of the sale, a share of common stock has a value..
You expect that the INR will depreciate against the dollar from its spot rate of $.0.15 to $.0.125 in 60 days. The following interbank lending and borrowing rates exist: How can you profit from the above given information. Estimate the profits that c..
Company Z's stock trades at $45 a share. The company is contemplating a 3-for-2 stock split. Currently, the company has EPS of $3.00, DPS of $0.50, and 20 million shares of stock outstanding. Assuming that the stock split will have no effect on the t..
Elements of the Statement of Cash Flows
Outdoor Sports is considering adding a miniature golf course to its facility. The course would cost $138,000, would be depreciated on a straight line basis over its 5-year life, and would have a zero salvage value. The project will require $3,000 of ..
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