The MEDCOM firm is currently selling for €32, with trailing 12-month earnings and dividends of €1.23 and €0.64, respectively. The Price to Earnings ratio (P/E) is 26, the Price to Book Value ratio (P/BV) is 6.5 and the Price to Sales ratio (P/S) is 2.8. The return on equity is 27 percent and the profit margin on sales is 11 percent. The Treasury bond rate is 4.5 percent, the equity risk premium is 6 percent and MEDCOM’s beta is 1.3. - Calculate the MEDCOM’s required return, based on the Capital Asset Pricing Model. - Assume that the dividend and earnings growth rates are 9.5%. Calculate the P/E, P/BV and P/S ratios that would be justified given the required rate of return in i) and current values of the dividend payout ratio, ROE and profit margin. - Given that the assumptions of the constant growth model are appropriate, state whether MEDCOM is fairly priced, overpriced, or underpriced.
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
The MEDCOM firm is currently selling for €32, with trailing 12-month earnings and dividends of €1.23 and €0.64, respectively. The Price to Earnings ratio (P/E) is 26, the Price to Book Value ratio (P/BV) is 6.5 and the Price to Sales ratio (P/S) is 2.8. The
- Calculate the MEDCOM’s required return, based on the
- Assume that the dividend and earnings growth rates are 9.5%. Calculate the P/E, P/BV and P/S ratios that would be justified given the required
- Given that the assumptions of the constant growth model are appropriate, state whether MEDCOM is fairly priced, overpriced, or underpriced.
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