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LOS a, (Part 1): Discuss the rationales for the use of price-to-earnings (P/E), price-to-book value (P/BV), price-to-sales (P/S), and price-to-cash flow (P/CF) in equity valuation.

A)	A disadvantage of the price/book value ratio is that it is not an appropriate measure for firms that primarily hold liquid assets.

B)	A rationale for using the price/cash flow ratio is that there is only one clear definition of cash flow.

C)	An advantage of the price/sales ratio is that it is meaningful even for distressed firms.

The P/S ratio is meaningful even for distressed firms, since sales revenue is always positive. This is not the case for the P/E and P/BV ratios, which can be negative.

In the P/BV ratio book value is an appropriate measure of net asset value for firms that primarily hold liquid assets.

Analysts use several different definitions of cash flow (CFO, adjusted CFO, FCFE, EBITDA, etc.) to calculate P/CF ratios.

When earnings are negative, the P/E ratio is meaningless.

One advantage of using price-to-book value (PBV) multiples for stock valuation is that:

A)	most of the time it is close to the market value.

B)	book value of a firm can never be negative.

C)	it is a stable and simple benchmark for comparison to the market price.

Book value provides a relatively stable measure of value that can be compared to the market price. For investors who mistrust the discounted cash flow estimates of value, it provides a much simpler benchmark for comparison. Book value may or may not be closer to the market value. A firm may have negative book value if it shows accounting losses consistently.

Which of the following is NOT an advantage of using price-to-book value (PBV) multiples in stock valuation?

A)	Book value is often positive, even when earnings are negative.

B)	Book values are very meaningful for firms in service industries.

C)	PBV ratios can be compared across similar firms if accounting standards are consistent.

Of the following types of firm, which is most suitable for P/B ratio analysis?

A)	A firm with accounting standards consistent to other firms.

B)	A firm with accounting standards different from other firms.

C)	A service industry firm without significant fixed assets.

Assuming consistent accounting standards across firms, P/B ratios can reveal signs of misvaluation across firms.

One advantage of price/sales (P/S) multiples over price to earnings (P/E) and price-to-book value (PBV) multiples is that:

A)	P/S is easier to calculate.

B)	Regression shows a strong relationship between stock prices and sales.

C)	P/S can be used for distressed firms.

Unlike the PBV and P/E multiples, which can become negative and not meaningful, the price/sales multiple is meaningful even for distressed firms (that may have negative earnings or book value).

Which of the following is least likely a reason the price to cash flow (P/CF) model has grown in popularity?

A)	CFs are generally more difficult to manipulate than earnings.

B)	CFs are used extensively in valuation models.

C)	CFs are more easily estimated than future dividends.

LOS a, (Part 2): Discuss the possible drawbacks to the use of price-to-earnings (P/E), price-to-book value (P/BV), price-to-sales (P/S), and price-to-cash flow (P/CF) in equity valuation.

One disadvantage of using the price/sales (P/S) multiple for stock valuation is that:

A)	profit margins are not consistent across firms within an industry.

B)	P/S multiple does not provide a framework to evaluate the effects of corporate policy decisions and price changes.

C)	sales are relatively stable and might not change even though earnings and value might change significantly.

The stability of sales (relative to earnings and book value) can be a disadvantage. For example, revenues may remain stable but earnings and book values can drop significantly due to a sharp increase in expenses.

Which of the following is least likely an advantage of using price/sales (P/S) multiple?

A)	P/S multiples provide a meaningful framework for evaluating distressed firms.

B)	P/S multiples are more reliable because sales data cannot be distorted by management.

C)	P/S multiples are not as volatile as P/E multiples and hence may be more reliable in valuation analysis.

Accounting data on sales is used to calculate the P/S multiple. The P/S multiple is thought to be more reliable only because sales figures are not as easy to manipulate as the earnings and book value, both of which are significantly affected by accounting conventions.

Which of the following is a disadvantage of using price-to-sales (P/S) multiples in stock valuations?

A)	It is difficult to capture the effects of changes in pricing policies using P/S ratios.

B)	P/S multiples are more volatile than price-to-earnings (P/E) multiples.

C)	The use of P/S multiples can miss problems associated with cost control.

Due to the stability of using sales relative to earnings in the P/S multiple, an analyst may miss problems of troubled firms concerning its cost control. P/S multiples are actually less volatile than P/E ratios, which is an advantage in using the P/S multiple. Also, P/S ratios provide a useful framework for evaluating effects of pricing changes on firm value.

An argument against using the price to cash flow (P/CF) valuation approach is that:

A)	cash flows are not as easy to manipulate or distort as EPS and book value.

B)	price to cash flow ratios are not as volatile as price-to-earnings (P/E) multiples.

C)	non-cash revenue and net changes in working capital are ignored when using earnings per share (EPS) plus non-cash charges as an estimate.

Items affecting actual cash flow from operations are ignored when the EPS plus non-cash charges estimate is used. For example, non-cash revenue and net changes in working capital are ignored. Both remaining responses are arguments in favor of using the price to cash flow approach.

An argument against using the price-to-earnings (P/E) valuation approach is that:

A)	research shows that P/E differences are significantly related to long-run average stock returns.

B)	earnings power is the primary determinant of investment value.

C)	earnings can be negative.

Negative earnings render the P/E ratio useless. Both remaining factors increase the usefulness of the P/E approach.

A)	P/S ratios do not express differences in cost structures across companies.

B)	P/S ratios are not as volatile as price-to-earnings (P/E) multiples.

C)	sales figures are not as easy to manipulate or distort as earnings per share (EPS) and book value.

P/S ratios do not express differences in cost structures across companies. Both remaining responses are advantages of the P/S ratios, not disadvantages.

Which of the following is a disadvantage of using the price-to-book value (PBV) ratio?

A)	Book value may not mean much for manufacturing firms with significant fixed costs.

B)	Book values are affected by accounting standards, which may vary across firms and countries.

C)	Firms with negative earnings cannot be evaluated with the PBV ratios.

The disadvantages of using PBV ratios are:

Book values are affected by accounting standards, which may vary across firms and countries.

Book value may not mean much for service firms without significant fixed costs.

Book value of equity can be made negative by a series of negative earnings, which limits the usefulness of the variable.