A3.5 MINICASE: PALM INC. In 2000 the firm 3Com spun out its personal digital assistant division as Palm Inc. On February 23, 2001, the financial services firm Telerate reported the following information about Palm. The closing price for a share of Palm was $21.69. Palm had 565,946,000 shares outstanding. Its book value of equity was $1,110,640,000. It held $742,888,000 in cash. Its trailing P/E was 181. Palm was an all-equity financed firm and had no debt. A3-12 Additional Resources for Chapter Three During a presentation to investors, Palms then CFO Judy Bruner was asked two questions. (1) What is Palms cost of capital? (2) What is Palms return on equity likely to be over the next several years? Palms CFO responded by saying that she thought that the firms cost of equity was 16 percent and that her best estimate for ROE was 26 percent per year for the next six years. The length of the horizon during which the expected ROE exceeds the required return on equity is called the CAP (an acronym for competitive advantage period). Assume that Palms managers plan to maintain its dividend payout ratio at zero for six years, the length of the CAP. The CFO of Palm also remarked that in view of recent volatility in the price of Palm stock, her firm was trying to understand how the market values Palm, relative to the right factors to value Palm. Its current price of about $22 was below the offer price of $38 that prevailed when Palm had gone public a year earlier. Palms CFO indicated that she focused on trailing P/E and price-to-sales, noting that these may send conflicting signals. For example, she indicated that the market assigned Palm a high P/E ratio (145 at the time) but, relative to other firms such as Handspring, a low price-to-sales ratio (8 at the time). (In 2001, Handspring was a separate firm, which competed with Palm. Palm acquired Handspring in 2003. Subsequently, the firm split itself into two, becoming PalmOne and PalmSource.)