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)2514 16

P/E ratio

(5-year average)2716 16

P/B ratio (current)103 3

P/B ratio

(5-year average)124 2

Beta1.51.1 1.0

Dividend yield0.3% 2.7%2.8%

a.TechSoft's shares have higher priceearnings (P/E) and pricebook value (P/B' ratios than those of A&E Corp. (The pricebook 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.

(25 marks)