The price/cash flow ratio is used to supplement the P/E ratio in company analysis because:
I. A firm's cash flow is typically subject to less accounting manipulation than reported earnings,
II. Cash flow has become an important measure of performance, value and financial strength because numerous academic studies have shown that various cash flow measures can be used to predict both success and future problems
III. Under theoretically ideal conditions, the market value of a firm should reflect its book value
IV. Cash flow data have become more accessible
V. It is easier to compute -
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A. B. C. D. E.E
Developing benchmark values for these ratios is important because, similar to P/Es and P/BV ratios, they are relative measures of value.
The price/cash flow ratio is used as a supplement to the price/earnings (P/E) ratio in company analysis for several reasons. Let's go through each statement and evaluate its accuracy:
I. A firm's cash flow is typically subject to less accounting manipulation than reported earnings.
This statement is true. Cash flow is generally considered to be a more reliable measure of a company's financial performance compared to reported earnings. Earnings can be subject to accounting manipulations and adjustments, whereas cash flow represents the actual cash generated or consumed by the business. Therefore, using the price/cash flow ratio can provide a clearer picture of a company's financial health.
II. Cash flow has become an important measure of performance, value, and financial strength because numerous academic studies have shown that various cash flow measures can be used to predict both success and future problems.
This statement is also true. Academic studies have highlighted the importance of cash flow as a predictor of a company's success or potential problems. Cash flow measures, such as free cash flow, operating cash flow, and cash flow from operations, provide insights into a company's ability to generate cash, meet its financial obligations, and invest in future growth. By considering these measures, investors can gain a deeper understanding of a company's performance, value, and financial strength.
III. Under theoretically ideal conditions, the market value of a firm should reflect its book value.
This statement is not directly related to the use of the price/cash flow ratio. The price/cash flow ratio focuses on comparing a company's market price to its cash flow, rather than its book value. Therefore, this statement is not a valid reason for using the price/cash flow ratio as a supplement to the P/E ratio.
IV. Cash flow data have become more accessible.
This statement is true. Over time, the availability and accessibility of cash flow data have improved. With advancements in technology and financial reporting standards, companies are required to disclose cash flow information in their financial statements. This increased accessibility makes it easier for analysts and investors to compute and utilize cash flow ratios in their analysis.
V. It is easier to compute.
This statement is true. Compared to the P/E ratio, which requires the use of earnings per share (EPS), the price/cash flow ratio is relatively easier to compute. Cash flow information is readily available in a company's financial statements, and the calculation only involves dividing the market price per share by the cash flow per share. This simplicity makes the price/cash flow ratio a convenient tool for quick company analysis.
Based on the accuracy of the statements, the correct answer is B. II, IV, V. These statements highlight the importance of cash flow measures, the improved accessibility of cash flow data, and the relative ease of computing the price/cash flow ratio compared to the P/E ratio.