CHAPTER 7 Stock Valuation 321The price/earnings (P/E) ratio, labeled “PE,” is next. It is calculated by divid-
ing the closing market price by the firm’s most recent annual earnings per share
(EPS). The price/earnings (P/E) ratio, as noted in Chapter 2, measures the amount
investors are willing to pay for each dollar of the firm’s earnings. McDonalds’ P/E
ratio was 23—the stock was trading at 23 times it earnings. The P/E ratio is
believed to reflect investor expectations concerning the firm’s future prospects:
Higher P/E ratios reflect investor optimism and confidence; lower P/E ratios
reflect investor pessimism and concern.
The daily volume, labeled “VOL 100s,” follows the P/E ratio. Here the day’s
sales are quoted in lots of 100 shares. The value 59195 for McDonalds indicates
that 5,919,500 shares of its common stock were traded on March 15, 2002. The
next column, labeled “LAST,” contains the last price at which the stock sold on
the given day. The value for McDonalds was $28.72. The final column, “NET
CHG,” indicates the change in the closing price from that on the prior trading
day. McDonalds closed up $0.57 from March 14, 2002, which means the closing
price on that day was $28.15.
Similar quotations systems are used for stocks that trade on other exchanges
such as the American Stock Exchange (AMEX) and for the over-the-counter
(OTC) exchange’s Nasdaq National Market Issues. Also note that when a stock
(or bond) issue is not traded on a given day, it generally is not quoted in the
financial and business press.
Review Questions
7–2 What risks do common stockholders take that other suppliers of long-
term capital do not?
7–3 How does a rights offering protect a firm’s stockholders against the dilu-
tion of ownership?
7–4 Explain the relationships among authorized shares, outstanding shares,
treasury stock, and issued shares.
7–5 What are the advantages to both U.S.-based and foreign corporations of
issuing stock outside their home markets? What are American depositary
receipts (ADRs)?
7–6 What claims do preferred stockholders have with respect to distribution of
earnings (dividends) and assets?
7–7 Explain the cumulative featureof preferred stock. What is the purpose of
a call featurein a preferred stock issue?
7–8 What is the difference between a venture capitalist (VC) and an angel cap-
italist (angel)?
7–9 Into what bodies are institutional VCs most commonly organized? How
are their deals structured and priced?
7–10 What general procedures must a private firm go through in order to go
public via an initial public offering (IPO)?
7–11 What role does an investment bankerplay in a public offering? Explain
the sequence of events in the issuing of stock.
7–12 Describe the key items of information included in a stock quotation.What
information does the stock’s price/earnings (P/E) ratio provide?