When considering the determinants of the price-to-book ratio (PB) which of the following is correct?

I. All other things being equal, the greater a company's return on common stockholders' equity, the greater the PB ratio.
II. All other things being equal, the greater a company's cost of equity, the greater the PB ratio.
III. If a company's return on common stockholders' equity equals its cost of equity, the PB ratio should equal 1.
IV. The greater a company's current earnings the higher the PB ratio.

A)I, III, and IV
B)I and III
C)II and IV
D)I and II

Question

When considering the determinants of the price-to-book ratio (PB) which of the following is correct?

I. All other things being equal, the greater a company's return on common stockholders' equity, the greater the PB ratio.
II. All other things being equal, the greater a company's cost of equity, the greater the PB ratio.
III. If a company's return on common stockholders' equity equals its cost of equity, the PB ratio should equal 1.
IV. The greater a company's current earnings the higher the PB ratio.

A)I, III, and IV
B)I and III
C)II and IV
D)I and II

Quizplus · Accepted Answer

I. All other things being equal, the greater a company's return on common stockholders' equity, the greater the PB ratio. This is correct as PB ratio measures the market value of a share as a multiple of its book value per share, and a higher return on equity indicates that the company is making more money per dollar invested by shareholders, which could lead to a higher market value.
II. All other things being equal, the greater a company's cost of equity, the greater the PB ratio. This statement is incorrect as the cost of equity is a discount rate used to calculate the present value of future cash flows, but it does not directly impact the market valuation of a company's shares.
III. If a company's return on common stockholders' equity equals its cost of equity, the PB ratio should equal 1. This statement is correct as the PB ratio is essentially the market's expectation of the future growth opportunities and profitability of a company, and if the return on equity is equal to the cost of equity, it implies that the market expects the company to be stable and grow at a rate that is not higher or lower than its cost of equity.
IV. The greater a company's current earnings the higher the PB ratio. This statement is incorrect as the PB ratio is based on the book value of a company and not its current earnings.

When Considering the Determinants of the Price-To-Book Ratio (PB) Which