Question

Ratios:

Current Ratio: 3.6093

Quick Ratio:                           2.1799

Times Interest Earned: 9.9143

ROE                                        16.48%

ROA                                        12.01%

Equity Multiplier                    1.3714

Inventory Turnover 1.3489

The P/E (Price/Earnings) Ratio is defined as: P/E ratio = Price per Common Share / Net Income per Common Share.

Which of the following statements are true with respect to the P/E Ratio?

Select one:

a. A P/E Ratio of 15 would tell us that each Common Stock is selling for 15 times the Net Income per common share

b. If you were an investor buying a Common Stock, you would hope that the P/E Ratio would go down after you purchased the shares.

c. If the firm’s Net Income per Common Share remained the same but the P/E Ratio went down, the firm’s stock price per Common Share would go up

d. All of the above statements are true

e. None of the above statements are true.

Answer 1

The correct answer is option (a).

P/E Ratio = Market price per share (MPS) / Earnings per share (EPS)

Hence, MPS = P/E Ratio * EPS

If EPS is $1, P/E ratio is 15, then MPS = 25

Hence, given statement is true.

Given statement (b) is false. P/E ratio falls if MPS or EPS falls. As an Investor, you will wish for a reduction in MPS or EPS.

Given statement (c) is also false. The correct statement will be, If firm's Net income per share remained same but P/E ratio went down, then the Firm's stock price per common share would go down.