bingning

79. Which of the following is the least accurate rationale to justify the use of price-tobook value (P/B) ratio as a measure of relative valuation of companies or common stocks?

A. P/B is a useful measure of value for firms that are not expected to continue as a going concern.
B. Compared to P/E, the P/B ratio is not influenced by such accounting effects as expensing a capital investment as opposed to capitalizing it.
C. P/B is particularly appropriate to value companies primarily composed of liquid assets, for example, those in the financial services industry.

Answer: B
“Introduction to Price Multiples,” John D. Stowe, CFA, Thomas R. Robinson, CFA, Jerald E. Pinto, CFA, and Dennis W. McLeavey, CFA
2009 Modular Level I, Volume 5, pp. 188-190
Study Session 14-59-a
Discuss the rationales for, and 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.
It is incorrect to say that P/B correctly reflects a company’s value. The historical cost basis of assets in P/B ratio is a drawback, not a rationale for using it as a measure of relative valuation.

80. An analyst is creating a new stock market index that is not affected by stock splits.
The index the analyst is least likely to develop is:

A. unweighted.
B. price-weighted.
C. value-weighted.

Answer: B
“Security-Market Indexes,” Frank K. Reilly, CFA, and Keith C. Brown, CFA
2009 Modular Level I, Volume 5, pp. 42-46
Study Session 13-53-a
Compare and contrast the characteristics of, and discuss the source and direction of bias exhibited by, each of the three predominant weighting schemes used in constructing stock market indexes, and compute a price-weighted, value-weighted and un-weighted index series for three stocks.
A price-weighted index, such as the Dow Jones Industrial Average, requires adjustment for stock splits. It is computed by summing the prices of individual stocks and dividing by a divisor that is adjusted for stock splits such that the index value is the same before and after the split.

81. An analyst gathers the following information about a company:

Common stock $1.50 par value – Authorized	5,000,000 shares
-- Issued	4,000,000 shares
Additional paid-in-capital	$20,000,000
Retained earnings	$5,000,000
Treasury stock (500,000 shares)	$10,000,000
Current price per share	$21

The price-to-book (P/B) ratio of the company is closest to:

A. 2.31.
B. 3.50.
C. 4.20.

Answer: B
“Introduction to Price Multiples,” John D. Stowe, CFA, Thomas R. Robinson, CFA, Jerald E. Pinto, CFA, and Dennis W. McLeavey, CFA
2009 Modular Level I, Volume 5, pp. 191-193
Study Session 14-59-b
Calculate and interpret P/E, P/BV, P/S, and P/CF.
Number of issued and outstanding shares = 4 m – 0.5 m = 3.5 m; (Issued – Treasury
Stock)
BV per share = 4m shares (1.50) + $20 m + $5 m - $10 m = $21 m / 3.5 m sh. = $6.00
Price-to-book value = $21 / $6.00 = 3.50