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Palm Parameters High initial ROE Palm Long-term ROE Palm rE Palm # shares Palm stock Note: When you develop the expected earnings column, use the...

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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 equity
Palm was an all-equity financed firm and had no debt. During a presentation to investors, Palm’s CFO Judy Bruner was asked two questions. (1) What is Palm’s cost of capital? (2) What is Palm’s return on equity likely to be over the next several years? Palm’s CFO responded by saying that she thought that the firm’s 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 Palm’s 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.
Palm’s 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.)
Case Analysis Questions
1. On the basis of the data presented in the case, use the textbook techniques to compute the fundamental value of Palm on February 23, 2001. The file Chapter 2 answer template.xls (available on the book Web site, www.mhhe.com/shefrin) is a spreadsheet that is set up along the lines of the textbook valuation of eBay’s stock.
Palm Parameters Palm FVE ? High initial ROE Palm 26% Palm FVE per share ? Long-term ROE Palm 16% rE Palm 16% Market Price ? # shares Palm stock 565,946,000 EPS1 ? P/E market ? Short-term dividend payout ratio 0% P/E fundamental ? Long-term dividend payout ratio 50% 1/rE ? Initial book value $1,110,640,000 Initial cash position $742,888,000 Initial cash position per share $1.31 CAP 6 FVE = ? Period ROE Earnings Dividends FVE Retained Earnings Book Value Computed as Discounted Dividends =Earnings-Dividends 0 ? ? 1 ? ? ? ? ? ? 2 ? ? ? ? ? ? 3 ? ? ? ? ? ? 4 ? ? ? ? ? ? 5 ? ? ? ? ? ? 6 ? ? ? ? ? ? 7 ? ? ? ? ? ? 8 ? ? ? ? ? ? 9 ? ? ? ? ? ? 10 ? ? ? ? ? ? 11 ? ? ? ? ? ? 12 ? ? ? ? ? ? 13 ? ? ? ? ? ? 14 ? ? ? ? ? ? 15 ? ? ? ? ? ? 16 ? ? ? ? ? ? 17 ? ? ? ? ? ? 18 ? ? ? ? ? ? 19 ? ? ? ? ? ? 20 ? ? ? ? ? ? 21 ? ? ? ? ? ? 22 ? ? ? ? ? ? 23 ? ? ? ? ? ? 24 ? ? ? ? ? ? 25 ? ? ? ? ? ? 26 ? ? ? ? ? ? 27 ? ? ? ? ? ? 28 ? ? ? ? ? ? 29 ? ? ? ? ? ? 30 ? ? ? ? ? ? 31 ? ? ? ? ? ? 32 ? ? ? ? ? ? 33 ? ? ? ? ? ? 34 ? ? ? ? ? ? 35 ? ? ? ? ? ? 36 ? ? ? ? ? ? 37 ? ? ? ? ? ? 38 ? ? ? ? ? ? 39 ? ? ? ? ? ? 40 ? ? ? ? ? ? Note: When you develop the expected earnings column, use the relationship Earnings = ROE x Book Value of Equity in prior year
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Palm Parameters Palm FVE ? High initial ROE Palm 26% Palm FVE per share ? Long-term ROE Palm 16% rE Palm 16% Market Price ? # shares Palm stock 565,946,000 EPS1 ? P/E market ? Short-term dividend payout ratio 0% P/E fundamental ? Long-term dividend payout ratio 50% 1/rE ? Initial book value $1,110,640,000 Initial cash position $742,888,000 Initial cash position per share $1.31 CAP 6 FVE = ? Period ROE Earnings Dividends FVE Retained Earnings Book Value Computed as Discounted Dividends =Earnings-Dividends 0 ? ? 1 ? ? ? ? ? ? 2 ? ? ? ? ? ? 3 ? ? ? ? ? ? 4 ? ? ? ? ? ? 5 ? ? ? ? ? ? 6 ? ? ? ? ? ? 7 ? ? ? ? ? ? 8 ? ? ? ? ? ? 9 ? ? ? ? ? ? 10 ? ? ? ? ? ? 11 ? ? ? ? ? ? 12 ? ? ? ? ? ? 13 ? ? ? ? ? ? 14 ? ? ? ? ? ? 15 ? ? ? ? ? ? 16 ? ? ? ? ? ? 17 ? ? ? ? ? ? 18 ? ? ? ? ? ? 19 ? ? ? ? ? ? 20 ? ? ? ? ? ? 21 ? ? ? ? ? ? 22 ? ? ? ? ? ? 23 ? ? ? ? ? ? 24 ? ? ? ? ? ? 25 ? ? ? ? ? ? 26 ? ? ? ? ? ? 27 ? ? ? ? ? ? 28 ? ? ? ? ? ? 29 ? ? ? ? ? ? 30 ? ? ? ? ? ? 31 ? ? ? ? ? ? 32 ? ? ? ? ? ? 33 ? ? ? ? ? ? 34 ? ? ? ? ? ? 35 ? ? ? ? ? ? 36 ? ? ? ? ? ? 37 ? ? ? ? ? ? 38 ? ? ? ? ? ? 39 ? ? ? ? ? ? 40 ? ? ? ? ? ? This worksheet is for you to develop the FVE of Palm when it pays out 100% of its earnings as dividends, as part of the PVGO approach.
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8436335.xls

Palm Parameters
High initial ROE Palm
Long-term ROE Palm
rE Palm
# shares Palm stock Note: When you develop
the expected earnings
column, use the
relationship
Earnings = ROE x Book
Value of Equity...

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