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Chapter 4: 11DQ (page 319)

What factors might influence a firm鈥檚 price-earnings ratio?

Short Answer

Expert verified

P/E ratio is affected by several factors some of the common factors are - earnings and sales growth of the firm, the risk (or volatility in performance), the debt-equity structure of the firm, the dividend policy, and the quality of management.

Step by step solution

01

Price-earnings ratio

Price-earnings ratio is a kind of multiplier that is applied to current earnings to compute the value of a share in the market. It is the ratio between the price of the share and earnings per share.

02

Factors influencing the price-earnings ratio

Following are the factors that may impact the P/E ratio 鈥�

a) Earnings and sales growth

b) Risk associated with security

c) Debt-equity structure of the firm

d) Dividend policy

e) Management quality and performance

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Most popular questions from this chapter

Debby鈥檚 Dance Studios is considering the purchase of new sound equipment that will enhance the popularity of its aerobics dancing. The equipment will cost \(27,900. Debby is not sure how many members the new equipment will attract, but she estimates that her increased annual cash flows for each of the next five years will have the following probability distribution. Debby鈥檚 cost of capital is 15 percent.

Cash Flow Probability

\)4,570 ........................ 0.1

5,550 ........................ 0.3

7,400 ........................ 0.4

9,930 ........................ 0.2

a. What is the expected value of the cash flow? The value you compute will apply to each of the five years.

b. What is the expected net present value?

c. Should Debby buy the new equipment?

Barry鈥檚 Steroids Company has $1,000 par value bonds outstanding at 16 percent interest. The bonds will mature in 40 years. If the percent yield to maturity is 13 percent, what percent of the total bond value does the repayment of principal represent?

You are going to receive $205,000 in 18 years. What is the difference in present value between using a discount rate of 12 percent versus 9 percent?

X-Tech Company issued preferred stock many years ago. It carries a fixed dividend of $12.00 per share. With the passage of time, yields have soared from the original 10 percent to 17 percent (yield is the same as required rate of return).

a. What was the original issue price?

b. What is the current value of this preferred stock?

c. If the yield on the Standard & Poor鈥檚 Preferred Stock Index declines, how will the price of the preferred stock be affected?

The Pan American Bottling Co. is considering the purchase of a new machine that would increase the speed of bottling and save money. The net cost of this machine is \(60,000. The annual cash flows have the following projections:

Year

Cashflow

1

\)23,000

2

26,000

3

29,000

4

15,000

5

8,000

a. If the cost of capital is 13 percent, what is the net present value of selecting a new machine?

b. What is the internal rate of return?

c. Should the project be accepted? Why?
See all solutions

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