ACCA Financial Management (F9) Certification Practice Exam

What is the purpose of the P/E ratio?

1. To measure market price per share relative to earnings

2. To assess the value of a company's assets

3. To calculate the average return on equity

4. To determine liquidity position of a company

The correct answer is: To measure market price per share relative to earnings

The purpose of the Price-to-Earnings (P/E) ratio is indeed to measure the market price per share relative to earnings. This financial metric is widely used by investors to evaluate a company's valuation and determine how much they are willing to pay for a dollar of earnings. A high P/E ratio may indicate that the market expects future growth and is willing to pay a premium for the stock, while a low P/E ratio may suggest a company is undervalued or has stagnant growth prospects. It is important to understand that the P/E ratio can vary significantly across industries, as some sectors have higher growth potentials than others, which might justify higher P/E ratios. By comparing a company's P/E ratio to its peers or the industry average, investors can gain insights into its relative valuation. In contrast, the other options relate to different financial metrics and analysis aspects: one assesses asset values, another looks at equity returns, and the final one deals with liquidity. These concepts do not pertain to the fundamental purpose of the P/E ratio.