Question #2
Reading: Reading 22 Market-Based Valuation - Price and Enterprise Value Multiples
PDF File: Reading 22 Market-Based Valuation - Price and Enterprise Value Multiples.pdf
Page: 1
Status: Incorrect
Correct Answer: B
Your Answer: C
Question
An increase in growth will cause a price-to-earnings (P/E) multiple to:
Answer Choices:
A. there is insufficient information to tell
B. decrease
C. increase
Explanation
An increase in growth will decrease the denominator and increase the numerator in the
trailing P/E expression, both of which should increase the P/E ratio:
P0/E0 = [(1 – b)(1 + g)] / (r – g)
Note that the topic review does not allow for any interactive relationship between
retention and growth. Thus, no explicit consideration is given to how the growth increase
was generated.