Question

Suppose a company has a preferred stock issue and a common stock issue. Both have just paid a $2 dividend. Which do you think will have a higher price, a share of the preferred or a share of the common?

Evaluate the following statement: Managers should not focus on the current stock value because doing so will lead to an overemphasis on short-term profits at the expense of long-term profits.

What are the difficulties of using the PE ratio to value stock?

Answer 1

1

Here , On can say that, common share might have more price then preferred share because of the following two reason

(1) All though preferred share has liquidation preference but it has fixed dividend and dividend will not rise or grow and return will remain same

(2) On the other hand Common share dividend has potential to grow in the future

So, Common shares will have a higher price

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2

The given statement is not correct because managers should focus on the current stock value because the current stock value represent the related risk, timing, and magnitude of related future cash flows, including both the short term as well we long-term. So managers should focus on the current stock value

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3

Following difficulties are there for using the PE ratio to value stock

• The earning of the company might be negative so in such case it will generate meaningless PE ratio
• Violate and temporary portion of the earning will make the interpretation of the PE ratio more difficult for analysis
• Discretion of the management of the company within the allowed accounting practice might distort the reporting earning and so Lessen the comparability of the PE ratio across the firm