Question

38) Plax, Incorporated is a medical equipment company that has earnings of $172.80 million and 24 million shares outstanding. It currently trades in the market at $108. You observe other companies in the market that have the following Price-to-Earnings (P/E) ratio.

Company	P/E Ratio
Geld Mining Company	28.0
Roberts Medical Equipment, Inc.	13.0
Brightside Medical Equipment, Inc.	13.1
Linguo Office Supplies, Inc.	24.2
Springfield Medical Equipment, Inc	12.9

Would you recommend buying this stock? Why or why not?

Multiple Choice

• No, do not buy the stock, because the stock is worth only $131 per share.

• No, do not buy the stock, because it will likely fall to 93.60 per share.

• Yes, buy the stock, because it will likely rise to $131.33 per share.

• Yes, buy the stock, because it is worth $93.60 per share.

• There is not enough data to make a recommendation.

Answer 1

Price of share = EPS * PE ratio

EPS = net income / shares outstanding

EPS of Plax = $172.80 million / $24 million = $7.20

Average PE ratio of medical equipment companies = (13.0 + 13.1 + 12.9) / 3 = 13.0

Value per share of Plax =  EPS * PE ratio

Value per share of Plax =  $7.20 * 13.0

Value per share of Plax =  $93.60

However, the current market price is $108. Therefore, the share is overvalued.

The correct answer is - No, do not buy the stock, because it will likely fall to 93.60 per share.