Suppose the following hypothetical data represent total assets, book value, and market value of common shareholders’ equity (dollar amounts in millions) for Microsoft, Intel, and Dell, three firms involved in different aspects of the computer technology industry. Microsoft engages primarily in the development, manufacture, license, and support of software products. Intel develops and manufactures semiconductor chips and microprocessors for the computing and communications industries. Dell designs and manufactures a range of computer hardware systems, such as laptops, desktops, and servers. These data also include hypothetical market betas for these three firms and analysts’ consensus forecasts of net income for Year +1. 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 4.0% and the market risk premium is 5.0%.

REQUIRED

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. Project residual income for Year þ1 for each firm.

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.

(amounts in millions) Microsoft Intel Dell Total assets $ 77,888 $ 50,715 $26,500 Common equity: Book value $ 39,558 $ 39,088 $ 4,271 Market value $264,510 $112,480 $26,000 Market equity beta Analysts' consensus forecasts 0.96 1.12 1.28 of net income for Year +1 $ 16,250 $ 8,060 $ 1,882