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Chapter 2: 2-1DQ (page 46)

Discuss some financial variables that affect the price-earnings ratio

Short Answer

Expert verified

The price-earning ratio is affected by the growth in revenues and the return on equity.

Step by step solution

01

Growth in earning and sales 

The primary factor that may affect the price-earning ratio is growth in income. The investors are willing to invest in the companies whose income is growing year to year becausethey have proven consistent growth over a period of time.

02

Return on equity and return on capital employed 

The price earning ratio will be determined by the return on equity and the return on capital employed.The equity holders are willing to pay a higher price only if the company earns a substantially better return on the capital,leading to a better price-earning ratio.

03

Additional Factors 

There are also other factors like the dividend payment policy and management quality which affect the price-earnings ratio. The ratio is usually future-oriented and will be higher when the firm has better prospects.

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