LOS c, (Part 2): Discuss possible drawbacks to the use of each price multiple and dividend yield.

Q1. 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.

Q2. 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)   Firms with negative earnings cannot be evaluated with the PBV ratios.

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

Q3. Which of the following is NOT an advantage of using price-to-book value (PBV) multiples in stock valuation?

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

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

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

Q4. An argument against using the price-to-sales (P/S) valuation approach is that:

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

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

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

Q5. 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.

LOS c, (Part 2): Discuss possible drawbacks to the use of each price multiple and dividend yield. fficeffice" />

Q1. 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.

Correct answer is C)

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.

Q2. 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)   Firms with negative earnings cannot be evaluated with the PBV ratios.

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

Correct answer is C)

The disadvantages of using PBV ratios are:

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

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

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

Q3. Which of the following is NOT an advantage of using price-to-book value (PBV) multiples in stock valuation?

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

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

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

Correct answer is A)

Book values are not very meaningful for firms in service industries.

Q4. An argument against using the price-to-sales (P/S) valuation approach is that:

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

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

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

Correct answer is B)

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

Q5. 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.

Correct answer is C)

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.

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