Discuss some financial variables that affect the price-earnings ratio. (LO2-2)
To Explain: The financial variables that affect the the price/earnings ratio.
Introduction:
Price/Earnings ratio:
The price/earnings ratio is a way of valuing a company's shares and provides information about the share price being overvalued or undervalued.
Answer to Problem 1DQ
Factors like earnings growth rate, company's share price, and quality of management affect the price/earnings ratio.
Explanation of Solution
The first factor is the earnings growth rate. An increase in the earnings of the firm with the share price being constant means that the share price of the company is undervalued.
Similarly, the second factor, which is the company's share price, affects the ratio as well. An increase in the share price of the company with the earnings being constant means that the share price of the firm is overvalued.
The third factor is the quality of management. It affects the ratio because the way the management works and is able to generate sales and earnings are important, and hence, it plays a crucial role in determining the ratio.
The main purpose of the price/earnings ratio is to provide information about the stability of the business operations of a firm in order to enable comparison with its peers, work upon its limitations, and consequently, make the required changes.
Want to see more full solutions like this?
Chapter 2 Solutions
Foundations of Financial Management
- Which of the following is NOT one of the ratios in Profitability group? Select one: a. Quick ratio b. Gross profit margin c. Return on Assets d. Operating profit marginarrow_forwardWhat are the siginificance of financial ratios (i.e. current ratio; DSO; TATO; profit margin; ROA; ROI)? How do they help us interpert financial data? What are the differences between ratios (i.e. profiability; liquidity; leverage)? What information do they provide for us?arrow_forward1. Which one of the following is not a characteristic generally evaluated in analyzing financial statements? a. Liquidity b. Profitability c. Solvency d. Marketability 2. What is the most widely used liquidity ratio? a. Quick ratio b. Inventory turnover c. Current ratio d. Debt ratioarrow_forward
- Which of the following ratios is not used to analyzeprofitability?a. Net profit margin ratio.b. Gross profit percentage.c. Current ratio.d. Return on equityarrow_forwardWhich one of the following is an advantage of LIFO? a. In periods of rising prices, less income taxes are paid b. In periods of rising prices, more holding gains are reported in net income c. Record keeping and financial statement preparation are easier d. Conservative income statement and balance sheet disclousures result from falling pricesarrow_forwardExplain what is financial ratio analysis?arrow_forward
- 1. Would you prefer financial ratios based on market or book values? Explain with examplesarrow_forwardWhich one of the following methods is based on net profit rather than cash flows? a. net present value b. payback c. internal rate of return d. accounting rate of return e. profitability indexarrow_forwardWhich of the following best describes the current ratio? a) Liquidity ratio b) Debt ratio c) Operating performance ratio d) Efficiency ratioarrow_forward
- A. Compute the following: 1. Horizontal and Vertical Analysis 2. Liquidity Ratios 3. Profitability Ratio 4. Efficiency Ratio 5. Financial Leveragearrow_forwardI need exampel on: Price - to -earning ratio Price book ratio Price to cash flow ratioarrow_forwardPrepare the following Ratio Analysis: 1. Liquidity ratio 2. Activity ratio 3. Solvency Ratio 4. Profitability Ratioarrow_forward
- Financial Reporting, Financial Statement Analysis...FinanceISBN:9781285190907Author:James M. Wahlen, Stephen P. Baginski, Mark BradshawPublisher:Cengage LearningCentury 21 Accounting Multicolumn JournalAccountingISBN:9781337679503Author:GilbertsonPublisher:Cengage