Strategic corporate finance Essay Example | Topics and Well Written Essays - 2000 words - 1

Strategic corporate finance - Essay ExamplePrice-to earnings ratios as a system of share valuation aids in the determination of whether a company is undervalued or overvalued, however, P/E ratio has a number of limitations or pitfalls and is further valid in specific circumstances. Its return is undermined by the fol mortifieding factors. The first factor is score. Earnings from which is it derived is an accounting figure that is determined under the guidance of accounting rules known as Generally Accepted accounting Principles, GAAP) that are subject to change and they usually vary from one country to another (Barnhart & Giannetti 2009 79). Therefore, EPS can be squeezed, twisted and prodded into numerous numbers depending on how one decides to do the books. It is therefore subjective and the figures being compared may not be the same. The second factor that limits the usefulness of P/E ratio is ostentation. During times of high inflation, P/E ratio tends to e much lower becaus e the market normally views the earnings as being artificially distorted upwards (Ball 2012 327). During such times, depreciation as well as inventory be tends to be understated since the replacement costs of equipment as well as goods increase with the rise in general level of prices. Information therefore, makes it hard to value the shares because past information is often little useful today. P/E ratio cannot therefore give a clear picture regarding the valuation of the shares of the company in times of high inflationAnother limitation is about market interpretations. The values of P/E can be interpreted in a number of ways, for instance, a low P/E ratio may mean that the company is undervalued. On the other hand, it may indicate that the market thinks that the firm in question is headed for vex or problems in the near future. This implies that the earnings of the company will reduce lower than expected (Ball 2012 330).It is clear that companies are able to manipulate