Q2) HKBU's investment club wants to buy the stock of either TechSoft Inc. or A&E Corp. In this connection, HKBU 's investment club prepared the following table. You have been asked to help them interpret the data, based on your forecast for a healthy economy and a strong stock market over the next 12 months.

TechSoft Inc.A&E Corp. S&P 500 Index

Current price$30$32

IndustryComputer softwareCapital goods

P/E ratio (current)251416

P/E ratio

(5-year average)271616

P/B ratio (current)1033

P/B ratio

(5-year average)1242

Beta1.51.1 1.0

Dividend yield0.3% 2.7%2.8%

a.TechSoft's shares have higher price?earnings (P/E) and price?book value (P/B' ratios than those of A&E Corp. (The price?book ratio is the ratio of market value to book value.) Briefly discuss why the disparity in ratios may not indicate that TechSoft's shares are overvalued relative to the shares of A&E Corp. Answer question in terms of the two ratios and assume that there have been no extraordinary events affecting either company.

b.Using a constant-growth dividend discount model, HKBU's investment club estimated the value TechSoft to be $28 per share and the value of A&E Corp. to be $34 per share. Briefly discuss weaknesses of this dividend discount model and explain why this model may be less suitable for valuing TechSoft than for valuing A&E Corp.

c.Recommend and justify a more appropriate dividend discount model for valuing^- TechSoft's common stock.

Table 19C Essential Company ($ millions, except shares outstanding) 1986 1987 1988 1989 1990 Income Statement Summary Sales $5,652 $6,990 $7,863 $8,281 $7,406 Earnings before interest and taxes (EBIT) $ 568 S 901 $1,037 $ 708 $ 795 Interest expense (net) (147) (188) (186) (194) (195, Income before taxes $ 421 $ 713 $ 851 514 $ 600 Income taxes (144) (266) (286) (173) (206J Tax rate 34% 37% 33% 34% 34% Net income $ 277 $ 447 $ 565 $ 341 $ 394 Preferred dividends (28) (17) (17) (17) (0 Net income to common $ 249 $ 430 $ 548 $ 324 $ 394 Common shares outstanding (millions) 196 204 204 205 201 Balance Sheet Summary Current assets $1,235 $1,491 $1,702 $1,585 $1,367 Timberland assets 649 625 621 612 615 Property, plant, and equipment 4,370 4,571 5,056 5,430 5,854 Other assets 360 555 473 472 429 Total assets $6,614 $7,242 $7,852 $8,099 $8,265 Current liabilities $1,226 $1,186 $1,206 $1,606 $1,816 Long-term debt 1,120 1,340 1,585 1,346 1,585 Deferred taxes 1,000 1,000 1,016 1,000 1,000 Equity-preferred 364 350 350 400 0 Equity-common 2,904 3,366 3.695 3,747 3,864 Total liabilities and equity $6,614 $7,242 $7,852 $8,099 $8,265