Question #81
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: 29
Status: Unattempted
Correct Answer: A
Question
A decrease in the earnings retention rate will cause a price-to-sales (P/S) multiple to:
Answer Choices:
A. increase
B. decrease
C. remain the same
Explanation
A decrease in the earnings retention rate will increase the following expression for P/S due
to the implied increase in the payout ratio, which is (1 – b):
P0 / S0 = [(E0 / S0) (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 whether the increase in
the payout ratio will cause an offsetting decrease in growth.