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Question - You have been asked to assess whether Midway Banks, a small banking company, is being valued correctly by the market. There are 10 million shares outstanding, trading at $ 20 per share but the book value of equity in the company is $250 million. The bank is expected to have net income of $ 20 million next year and this income is expected to grow 3% a year in perpetuity (with the return on equity remaining unchanged at existing levels). The risk free rate is 5%, the beta for small banks is 1.0 and the market risk premium is 4%.
Required -
a. Based upon the fundamentals, what price to book ratio should Midway Banks be trading at?
b. If the market is correct in pricing this stock, estimate the cost of equity that the market is assuming for this bank.
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