Kingpin804

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

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

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

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

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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.

Kingpin804

The price to book value ratio (P/BV) is a helpful valuation technique when examining firms:

A) with older assets compared to those with newer assets.

B) with the same stock prices.

C) that hold primarily liquid assets.

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P/BV analysis works best for firms that hold primarily liquid assets.

Kingpin804

Assume that the expected dividend growth rate (g) for a firm decreased from 5% to zero. Further, assume that the firm's cost of equity (k) and dividend payout ratio will maintain their historic levels. The firm's P/E ratio will most likely:

A) decrease.

B) become undefined.

C) increase.

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The P/E ratio may be defined as: Payout ratio / (k - g), so if k is constant and g goes to zero, the P/E will decrease.

Kingpin804

According to the earnings multiplier model, all else equal, as the required rate of return on a stock increases, the:

A) P/E ratio will increase.

B) P/E ratio will decrease.

C) earnings per share will increase.

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According to the earnings multiplier model, the P/E ratio is equal to P0/E1 = (D1/E1)/(ke − g). As ke increases, P0/E1 will decrease, all else equal.

Kingpin804

According to the earnings multiplier model, a stock’s P/E ratio (P0/E1) is affected by all of the following EXCEPT the:

A) required return on equity.

B) expected dividend payout ratio.

C) expected stock price in one year.

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According to the earnings multiplier model, the P/E ratio is equal to P0/E1 = (D1/E1)/(ke - g).
Thus, the P/E ratio is determined by:

• 
  The expected dividend payout ratio (D1/E1).
• 
  The required rate of return on the stock (ke).
• 
  The expected growth rate of dividends (g).

Kingpin804

The earnings multiplier model, derived from the dividend discount model, expresses a stock’s P/E ratio (P0/E1) as the :

A) expected dividend payout ratio divided by the difference between the required return on equity and the expected dividend growth rate.

B) expected dividend payout ratio divided by the sum of the expected dividend growth rate and the required return on equity.

C) expected dividend in one year divided by the difference between the required return on equity and the expected dividend growth rate.

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Starting with the dividend discount model P0 = D1/(ke − g), and dividing both sides by E1 yields: P0/E1 = (D1/E1)/(ke − g) Thus, the P/E ratio is determined by:

• The expected dividend payout ratio (D1/E1).
• The required rate of return on the stock (ke).
• The expected growth rate of dividends (g).

Kingpin804

If the payout ratio increases, the P/E multiple will:

A) decrease, if we assume that the growth rate remains constant.

B) always increase.

C) increase, if we assume that the growth rate remains constant.

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When payout ratio increases, the P/E multiple increases only if we assume that the growth rate will not change as a result.

Kingpin804

An analyst gathered the following information about an industry. The industry beta is 0.9. The industry profit margin is 8%, the total asset turnover ratio is 1.5, and the leverage multiplier is 2. The dividend payout ratio of the industry is 50%. The risk-free rate is 7% and the expected market return is 15%. The industry P/E is closest to:

A) 12.00.

B) 22.73.

C) 14.20.

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Using the CAPM: ki = 7% + 0.9(0.15 − 0.07) = 14.2%.
Using the DuPont equation: ROE = 8% × 1.5 × 2 = 24%.
g = retention ratio × ROE = 0.50 × 24% = 12%.
P/E = 0.5/(0.142 − 0.12) = 22.73.

Kingpin804

A firm has an expected dividend payout ratio of 48 percent and an expected future growth rate of 8 percent. What should the firm's price to earnings ratio (P/E) be if the required rate of return on stocks of this type is 14 percent and what is the retention ratio of the firm?

P/E ratio

Retention ratio

A) 8.0    52%

B) 6.5    52%

C) 6.5    48%

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P/E = (dividend payout ratio)/(k - g)
P/E = 0.48/(0.14 - 0.08) = 8
The retention ratio = (1 - dividend payout) = (1 - 0.48) = 52%

Kingpin804

All of the following factors affects the firm’s P/E ratio EXCEPT:

A) the required rate of return.

B) growth rates of dividends.

C) the expected interest rate on the bonds of the firm.

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The factors that affect the P/E ratio are the same factors that affect the value of a firm in the infinite growth dividend discount model. The expected interest rate on the bonds is not a significant factor affecting the P/E ratio.