Q137B
ExpertverifiedTricoat Paints has a current market value of $41 per share with earnings of $3.64. What is the present value of its growth opportunities (PVGO) if the required return is 9%?
Answer
$0.56
Price_{ }= $41
E_{1} = $3.64
k = 9%
PVGO =?
Price = E_{1 }/ k + PVGO
$41 = $3.64 / 0.09 + PVGO
PVGO = $0.56
Phoebe Black’s investment club wants to buy the stock of either NewSoft, Inc. or Capital Corp. In this connection, Black prepared the following table. You have been asked to help her interpret the data, based on your forecast for a healthy economy and a strong stock market over the next 12 months.
 New soft Inc.  Capital Corp.  S & P 500 index 
Current Prices  $30  $32 

Industry  Computer Software  Capital Goods 

P/E ratio (current)  25  14  16 
P/E ration (5 yr average)  27  16  16 
Price/book ratio (current)  10  3  3 
Price/book ratio (5year average)  12  4  2 
beta  1.5  1.1  1.0 
Dividend yield  .3%  2.7%  2.8% 
a. Newsoft’s shares have higher price–earnings (P/E) and price–book value (P/B) ratios than those of Capital 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 NewSoft’s shares are overvalued relative to the shares of Capital Corp. Answer the question in terms of the two ratios, and assume that there have been no extraordinary events affecting either company.
b. Using a constantgrowth dividend discount model, Black estimated the value of NewSoft to be $28 per share and the value of Capital 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 NewSoft than for valuing Capital Corp.
c. Recommend and justify a more appropriate dividend discount model for valuing New Soft’s common stock.
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