Market data obtained from S&P Capital IQ is shown below:

• VMX Ltd has a beta of 1.3 and debt-to-equity ratio of 0.5
• Yield on long-term Singapore government bonds = 3%
• Yield on AAA-rated corporate bonds = 5%
• Bond price issued by VMX Ltd = $1,150 (6% coupon, paid semiannually, expiring in 8 years)
• Inflation rate = 1%
• Market risk premium = 6%
• Corporate tax rate is 17%.

Solve for VMX's weighted average cost of capital.

(b) VMX stock is currently trading at $25.80. Its most recent reported earnings per share was $1.20. Based on guidance provided by management at the recent investor's conference, earnings are expected to grow at 20% per year for the next 3 years, and 3% thereafter. The estimated dividend pay-out ratio is 50% for the next 3 years and 75% thereafter.

Verify whether VMX stock is correctly priced by the market.

I am unsure how to solve part (b) and hence, attaching part (a) information for your reference.

I tried using P/E ratio (the answer I got is 21.5 times) to verify but it does not make any sense to me.

I also tried using SML approach to find the required returned rate on this stock is 10.8%, but I am stuck as I cannot find the right formula where I can put this 10.8% to find what should be the actual market price for VMX stock.

 

Answer rating: 100% (QA)

To determine whether VMX stock is correctly priced by the market we can use the Dividend Discount Model DDM approach The DDM values a stock by calcula... View the full answer