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Ratios: Price-Earnings Ratio (PE Ratio) quiz #1 Flashcards

Ratios: Price-Earnings Ratio (PE Ratio) quiz #1
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  • What is the formula for calculating the Price-Earnings (PE) ratio?
    The PE ratio is calculated by dividing the market price per share by the earnings per share (EPS).
  • How do you calculate earnings per share (EPS)?
    EPS is calculated as (net income minus preferred dividends) divided by the average number of common shares outstanding.
  • How do you determine the average number of common shares outstanding?
    The average number of common shares outstanding is calculated by adding the beginning and ending balances of shares and dividing by two.
  • Why is the PE ratio important to investors?
    The PE ratio helps investors determine how much they are paying for each dollar of a company's earnings.
  • What does a low PE ratio indicate about a stock's value?
    A low PE ratio indicates that investors are paying less for each dollar of earnings, suggesting the stock may be undervalued.
  • What might a high PE ratio suggest about a company's future earnings?
    A high PE ratio may suggest that investors expect higher future earnings for the company.
  • If a company has a net income of $100,000, preferred dividends of $10,000, and an average of 45,000 common shares outstanding, what is its EPS?
    EPS = ($100,000 - $10,000) / 45,000 = $2.00 per share.
  • If the market price per share is $30 and the EPS is $2, what is the PE ratio?
    PE ratio = $30 / $2 = 15.
  • What does the numerator in the PE ratio formula represent?
    The numerator represents the current market price per share of common stock.
  • What does the denominator in the PE ratio formula represent?
    The denominator represents the earnings per share (EPS).
  • Why might preferred dividends be subtracted when calculating EPS?
    Preferred dividends are subtracted because EPS measures earnings available to common shareholders only.
  • If a company has 100,000 shares at the beginning of the year and 120,000 at the end, what is the average number of shares outstanding?
    Average shares outstanding = (100,000 + 120,000) / 2 = 110,000.
  • How does the PE ratio reflect market expectations?
    A higher PE ratio reflects higher market expectations for future earnings growth.
  • What type of stock would typically have a higher PE ratio, a growth stock or a value stock?
    A growth stock would typically have a higher PE ratio due to expectations of higher future earnings.
  • If a company’s PE ratio is significantly higher than the industry average, what might this indicate?
    It may indicate that investors expect the company to have higher future earnings growth compared to its peers.
  • What is the impact on the PE ratio if the market price increases but earnings per share remain the same?
    The PE ratio will increase if the market price increases while EPS remains unchanged.
  • What is the impact on the PE ratio if earnings per share increase but the market price stays the same?
    The PE ratio will decrease if EPS increases while the market price remains the same.
  • Why is it important to use the average number of shares outstanding when calculating EPS?
    Using the average number of shares accounts for changes in the number of shares during the period, providing a more accurate EPS.