土豆妮

An increase in financial leverage, assuming no change in the growth rate, will generally cause a price to cash flow (P/CF) ratio to:

A) there is insufficient information to tell.

B) increase.

C) decrease.

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An increase in financial leverage should increase the firm’s risk and consequently its required rate of return. This should decrease the P/CF ratio, as indicated by the following expression:

P₀ / CF₀ = (1 + g) / (r – g)

(Note: the reading does not allow for any interactive relationship between leverage and growth. Thus, no explicit consideration is given to whether the increase in leverage would increase return on equity (ROE) and therefore growth through the g = (ROE × retention) relationship.)

土豆妮

An increase in return on equity (ROE) will cause a price-to-book (P/B) multiple to:

A) increase.

B) decrease.

C) there is insufficient information to tell.

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An increase in ROE should increase the price to book (P/B) ratio:

P₀ / B₀ = (ROE – g) / (r – g)